Why Companies Are Buying Their Competition

Peter Sayles |

Why Companies Are Buying Their Competition

Reed just wanted a better way.

He hated the fact he was getting price gouged.

He would pay crazy high late-fees every time he rented a movie from Blockbuster. Getting charged a late-fee on Apollo 13 was the last straw.

Late fees were pure profits for Blockbuster. It made them $200 million dollars per year on late fees alone.

Blockbuster was king of the hill in movie rentals. They owned thousands of stores across the country. And business was going well.

The internet wasn’t yet the “thing.” Subscription businesses weren’t proven in this industry. And customers had no other choice.

This made Blockbuster CEO John Antioco a little too complacent with being the alpha in the movie rental business.

And what led Reed Hastings in creating Netflix.

Antioco completely ignored user behaviors. And laughed Reed Hastings out of the room when Hastings offered Netflix up for sale in 2000.

Hastings offered Netflix up for $50 million (a $75 million price tag today). Antioco said no. $50 million for a company whose market cap reached $5 billion in 2002 was a risk. But not one for a company people saw as the “up and coming disruptor.”

But we shouldn’t put all the blame on Antioco passing up on the $50 million price tag in 2000.

Antioco’s later successor – Jim Keyes – mocked Netflix altogether.

Blockbuster never seemed to take Netflix seriously.

First Antioco said online subscriptions were just a “niche business.”

Then Keyes saidNeither RedBox nor Netflix are even on the radar screen in terms of competition…It’s more Wal-Mart and Apple” in 2008.

Blockbuster filed for bankruptcy two years later. Netflix is now worth $142 billion.

This is just one example of major companies refusing to acknowledge change is coming.

If companies don’t innovate fast enough, they die. Quickly.

The world is as inter-connected as ever.

Big companies can innovate themselves. Or buy the competition.

If not, they’re gonners.

We’ll cover examples of both scenarios: companies refusing to innovate. And companies buying competition to remain the leaders.

We’re seeing a lot of both.

Finding out which direction the CEO is taking their company will help you make better investing decisions.

Let’s start with the biggest industry disruption of the century.

Uber Disrupts The Taxi Industry

Taxis have been around for decades.

Nothing has changed since.

You call the 1-800 taxicab hotline. Ask for a taxi to pick you up. Get a 30-45 minute window of when that’ll be. Get lucky if they’re on time.

Get in a taxi. Tell the driver your destination. Watch the driver press random buttons to turn on the billing meter. Then watch the meter go up 20 cents one second. 45 cents the next. Then who knows from there.

It was only a matter of time till some company disrupted that monopoly.

Uber started in March 2009. It’s now worth nearly $70 billion. (An incredible feat in 10 years.)

What’s happened to the Taxi industry since?

Medallian Financial Corp. (MFIN) – originates, acquires, and services loans to taxi medallions – fell over 85% from beginning of 2014 to the beginning of 2017.

Taxi unions are doing everything in their power to stop Uber, Lyft, and all other ride sharing apps from taking over their “territory.” (read here, here, and here). Some governments are obliging.

But the people have spoken.

We’re ready for change.

Companies That Bought The Competition

Companies are wising up though…

They’re buying the competition rather than competing with the competition. Reuters shows M&A over $2 trillion this year – a record. It’s not even September. We’re on pace to see over $4.3 trillion – an insane amount of money.

Mergermarket stated that there were 3,774 M&A deals in Q1 of 2018 alone – totaling $891 billion.

Companies aren’t taking as much risk because they can borrow billions for lower interest rates. (We actually think this is a great opportunity for Apple to buy Netflix).

But that’s beside the point. Here’s a couple example of companies buying the competition.

PepsiCo Buys SodaStream International

PepsiCo (PEP) just bought SodaStream International (SODA) for $3.2 billion.

It’s a move away from sugary snacks and drinks. And towards the healthier alternatives.

Pepsi isn’t naive. It knows what the customers want. It’s 2010 goal is to triple revenue to $30 billion from “nutritious” products by 2025.

SodaStream will help keep pace toward that 2025 goal.

SodaStream’s CEO said “shame on you” after PepsiCo launched its “premium water bottle brand” LIFEWTR. But the $3.2 billion pricetag was too big to hold any grudges.

Now, Pepsi should be back on target for its 2025 goal. SodaStream grew revenues 31% year over year.

Unilever Buys Dollar Shave Club

Statista pegs the men’s grooming industry at $20.5 billion.

P&G owns Gillette razors. Gillette razors take in about 65% of the market.

Unilever saw an opportunity to dethrone Procter & Gamble in the men’s shaving kit industry.

Rather than start its own razor company. It bought Dollar Shave Club for $1 billion. It immediately gave Unilever 17% market share.

It could’ve bought Edgewell (a spinoff of Energizer Holdings) – which owns Shick, Edge, and Shave Guard. But it chose to buy the innovator of razors instead.

Harry’s Razors have come along as a dominant player in the online subscription razor industry. Both have essentially uprooted P&G’s dominant hold on the men’s razor industry. P&G has cut its prices on razors multiple times. And now offers their own subscription.  

Procter & Gamble still makes billions off Gillette every year. But it was king of the hill for too long and got complacent.

It didn’t innovate. Which brought on Dollar Shave Club (now owned by its arch-rival Unilever) and Harry’s Razors.

We’ll see how the next decade goes for P&G in the razor industry.

Facebook Buys Instagram

Facebook knew it had to make a move.

It already had 850 million users in 2010. But Instagram launched and took the U.S. by storm in 2010.

It gained 25,000 users on the first day. One million in three months. Ten million in two years.

All of it organic growth. Not a dime spent in acquisition.

Instagram was exploding. But it was still pre-revenue.

Facebook chomped at the bit and bought Instagram for $1 billion. People mocked Facebook for the lofty price tag.

But Facebook has the last laugh. Instagram is now estimated to be worth $100 billion.

We think it’ll be worth a lot more over the coming years too.

Either way, Facebook 100x’d its purchase. And it’s a testament to buy the competition rather compete with it.

Conclusion

Companies are forced to innovate faster than ever before.

Consumers are fickle. But there’s one thing companies need to learn fast.

Figure out where the trend is moving. And innovate. Or die.

Companies can decide to outlay their own capital to compete with the “disruptor.”

Or they can buy their competition outright.

We laid out just a couple of examples. But nowadays, it’s easy to buy the competition. Whether it’s cash, debt, or equity.

Companies have more than $1 trillion in cash sitting on their balance sheet.

Companies like Apple, Microsoft, and Google all have over $100 billion in cash and short term bonds on their balance sheets alone. (Apple has over $250 billion in cash on its balance sheet. We think they’d be wise and consider spending up to buy Netflix.)

Warren Buffet’s Berkshire Hathaway also has over $100 billion in cash too.

Mergers and buyouts are at record highs this year. So you’re starting to see companies willing to spend the money. Especially when interest rates are still near record lows (a topic for another day).

Not every acquisition is the best move. Or the wisest use of their cash, equity, or debt.

But companies don’t want to become the next Blockbuster. They’ll be a case study for the rest of history if they fail to meet their competition head on.

That is why they  buy their competition. To leverage them to build empires – just like Facebook.

The choice is theirs.