Did McAfee Associates Inc land itself with a lemon when it agreed to buy Network General Corp? The stock market certainly thinks so. Whatever the compelling business reasons McAfee cites for the deal, the historical numbers tell a different story. The huge disparity between the growth rates of the two companies over the last few years has caught the eye of the markets and has dragged McAfee’s stock backwards with a jolt. In the last three years, McAfee’s revenues have been growing at 135%. Network General has managed a meager 28%. From October 1996 to October 1997, McAfee’s stock had appreciated by 32% compared with a fall of 15% for Network General. And since the all paper deal was announced on October 13th McAfee’s share price has lost a quarter of its value. McAfee’s CEO, William Larson, told all those who didn’t believe in the deal to jump ship immediately. He told them they were acting as a boat anchor but right now that anchor is attached firmly to Larson’s tail. McAfee is to offer 0.4167 shares for each Network General share but the world at large thinks McAfee is paying far too much for a company whose revenues, earnings and stock price simply aren’t as dynamic as its own.
Both companies are highly cash generative and both have solid looking, highly liquid balance sheets with very little debt. There is certainly no panic about the deal from the financial perspective. The problem arises in the valuation placed on Network General using the popular measurement tool of discounted cash flows. Using this technique the $1.2bn headline acquisition value (now down to just $895m) agreed on by McAfee can only be reached if discount factors are stretched to the absolute outside limit of shareholder acceptability. The analysis hasn’t yet been able to account for any cost savings or synergies in the merger, but McAfee’s presentation on the deal downplayed these as being minimal anyway. The deal is scheduled to be presented for shareholder approval on December 1st and there’s no doubt that angry McAfee shareholders will be there in numbers to ask some very pertinent questions about why Larson signed them into a deal which only had one possible outcome for the short term share price.