Why Apple Should Buy TomTom (I seem to have moved TomTom's shares 7% lol)
Blog post. Reasonably self-explanatory I think! http://uneasyempires.blogspot.co.uk/2012/10/why-apple-should-buy-tomtom.html
Edit (19th Oct) - Just a quick update I put a second post up today about how much Apple would potentially pay. Didn't really want to start a second thread as that would confuse the issue. But also don't want to be trolling for click throughs so I've pasted in the rest of the article at the bottom of this post. Apologies for the crap formatting.
The hilarious thing though is this series of blog posts seems to have been picked up by Bloomberg and added about €70m to TomTom's shares today. I never got that sort of attention when I worked in a big bank!
It's been a long month for Apple
Tomorrow marks a month since the release of iOS6, along with its universally derided mapping app. I have written extensively about why this was a retrograde step and what exactly is wrong with the app.
In the meantime Apple has made its apologies, gone on a mapping recruitment drive and begun fixing some of the more egregious errors. However I don't think that is enough. The key message from my analysis was that there were fundamental issues with the data and the engine couldn't be easily fixed. Also this is only the presenting issue.
The underlying problem Apple is grappling with is that mapping is simply a harder, messier business than they thought. Particular when their biggest competitor is going from strength to strength, and the third guy in the room is no slouch either (at making maps I mean. damn useless with phones though!).
In short Apple is under pressure both to accelerate the patching of the existing maps, and acquire some heavy duty mapping expertise.
Which is why Apple should buy TomTom.
What does TomTom offer?
The thing to understand is TomTom isn't just about the digital map. The map itself is, of course, useful. It's a database containing vector-based information about roads locations as well bunch of other datapoints (e.g. one-way systems, available turns at junctions, traffic frequency at different times of day etc.). The basic database for the US + Western Europe is a few gigabytes in size and would fit nicely on a microSD card.
But the value goes deeper than that. After all if it Apple already licence this map data already. But TomTom owns much more than that.
As important as the map is the network of relationships behind it. What most people don't realise is that the majority of digital mapping isn't done with cars - its done by getting the underlying GIS data from thousands of government agencies, utility companies and transportation companies and integrating it together. The hard bit about building a map isn't actually driving the roads - its about getting that data. It is noticeable that Google built out its US map much more quickly, because it could start with a core set of federal data rather than having to go to multiple providers. In contrast its build-out in Europe has been much slower as its been dealing with a much more fragmented market and much tougher regulator landscape. TomTom of course has had all these relationships for years, and this represents significant hidden value.
TomTom's Mapshare Reporter
As important as the relations is the people. Again although TomTom has seen swingeing job cuts of late it still employs hundreds of experience mapping experts. These guys don't simply grow on trees; to assemble a comparable outfit from scratch would take years. This represents a significant asset.
Finally there are is a raft of software and services which TomTom has built on top of Tele Atlas. In particular the database of Points of Information (PoIs - everything from service stations to restaurants and hotels), its Mapshare portal for crowdsourcing map updates, the routing algorithms to map out a journey and HD Traffic, its live traffic offering.
Note I am pretty much ignoring TomTom's (still significant) satnav hardware business. That's not to say its go zero value, but it has zero value to Apple.
The map is what matters.
Three reasons why Apple should do the deal
So why should Apple buy TomTom. I think there are three big issues to consider.
1) It accelerates the improvements to the current map
In my previous post I outlined identified three problems with initial release of iOS6 maps. a) wrong or incomplete map and PoI data, b) distorted or missing 3D images/textures and c) poor quality traffic routing or search queries. I also concluded that this isn't something Apple is going to be able to fix overnight, either because they are pretty fundamental engine issues or because it will take time to crowdsource the necessary data.
I don't think TomTom will help much with the 3D image/texture issues - that lies more with getting the right satellite data from DigitalGlobe or improving/changing the 3D engine from C3. However I think owning TomTom could significantly accelerate fixing the other problems.
- Integration: When it comes to wrong or incomplete map data, a lot of the problem wasn't that Apple didn't have the data, rather it wasn't integrating it correctly. Often the underlying TomTom map had the correct data, but Apple have overlaid incorrect information from third party sources. Owning TomTom will help this process along - as I pointed out earlier the raison d'etre of a mapmaker is exactly that - to correctly integrate data from a number of different sources.
- Faster map updates: Owning TomTom's map also accelerates the process of updates. If Apple use TomTom as a third party licencee they will always have to wait on TomTom to provide an updated dataset. If they own the company they can put updates straight through as soon as TomTom gets them.
- Crowdsourcing: TomTom also has a mature crowdsourcing portal called Mapshare. A bit part of Apple's ongoing fix is to get users to report problems and fill in the gaps - TomTom has years of expertise in managing this process and figuring out what user updates should filter through to its final map.
- Routing: Another area of mirth have been the routing snafus provided by Apple's turn-by-turn engine. To a degree these were inevitable (Google's turn-by-turn had similar problems in its initial versions). But an easy fix would be to throw in TomTom's mature and proven turn-by-turn engine.
Bear in mind TomTom is not a magic bullet. These are all issues that Apple can likely fix on its own. The issue is one of opportunity cost. If Apple can fix these all in three months then none of them are a compelling reason to buy TomTom (especially given the transaction would take some time to complete). However if (as I suspect) they will take much longer to fix then Apple need to consider the opportunity cost. Every extra month with the embarrassment of iOS6 Maps hanging round its neck is another month for Google to make hay and take mindshare amongst users.
2) It seriously bulks up Apple's mapping chops
But let's be clear - Apple wouldn't buy TomTom just to help fix the current iOS Maps. They're not that stupid. Actually the bigger reason to acquire TomTom isn't as a mapping elastoplast. Rather its to acquire lasting mapping expertise.
As I said the jewel in TomTom's crown isn't its map database. Its the people and the processes it has build up over the years. Although Apple are pushing hard to hire mapping experts, there simply aren't that many people out there with the necessary expertise. In contrast TomTom has hundreds of mapping experts and a stable, mature mapping organisation.
Also bear in mind that TomTom has genuine scarcity value. With Navteq now in the hands on Nokia/Microsoft, and Google highly unlikely to play ball, TomTom is the only major reservoir of mapping expertise on the market.
I think a good analogy is SAP's acquisition of Sybase back in 2010. What SAP ostensibly bought was a fairly ratty old relational database and a bunch of interesting BI technologies. What it actually bought is the brains and know-how of thousands of irreplaceable database experts. At the time Sybase was the only large standalone database vendor left - if SAP wanted bet its future on data, it had to bet on Sybase.
As this editorial in trade rag Directions Magazine points out - that is why Apple needs TomTom. This is an asset that money can't build, but it can certainly buy.
3) The deal can be done quickly and smoothly
I want to talk about the mechanics and psychology of the deal in a separate post (hopefully tomorrow). But I want to make the simple point that this is a deal which could be done quickly. TomTom's founders hold 48% of the company and "friendly" insiders Janivo/Cyrte hold another 10%.
So Apple will essentially be negotiating with the founders (and their egos). If you are a leading tech entrepeneur there is no one your would rather sell out to than the House That Jobs Built. Harold Goddijn, Apple Senior Vice President (Maps) would do nicely.
Get them onboard and its a done deal.
I think there would be minimal regulatory issues given Apple can point to Google and Nokia/Microsoft as large an significant competitors in the industry; Garmin might pipe up but I doubt they will have much sway.
And it goes without saying that with TomTom currently valued at $1.1bn and Apple's cash pile at $82bn (give or take vendor commitments) money won't be an issue. So far this maps kerfuffle has cost Apple a lot more than that!
Potential stumbling blocks
Before I finish a few notes concerning the case against. Why wouldn't Apple do this deal?
- Apple think they can fix maps quickly: If Apple think they can address the issues with Maps by Christmas, this takes away a big rationale to do the deal. As I said using TomTom to accelerate the Maps fix this isn't the only reason to buy TomTom, but its certainly a significant reason, IMHO.
- Apple think they can build mapping expertise themselves, or don't need it: If Apple think they can hire the mapping know-how themselves, or simply believe its not a high priority then they will not do this deal. I think the advantages of acquiring TomTom's scarce mapping know-how speak for themselves, and Apple are clearly pushing deeper and deeper into cloud services which means location MUST be a priority. However Apple may Think Different.
- This isn't a very "Apple" deal / Apple don't buy other brands: Apple's M&A has traditionally revolved around acquiring smaller companies for their technologies (e.g. Siri Inc for Siri, SoundJam for iTunes) and then throwing it down their broad marketing and distribution maw (what M&A bankers call a "top-line synergy). In the past they have rarely acquired more mature tech companies, especially not those with their own standalone brands. I think its dangerous to say though that "Apple never do x" (didn't Steve Jobs say he'd never do a smaller iPad?). The strategic landscape has changed, and Apple is now much bigger. I think to say Apple will never acquire a larger branded company is foolhardy. TomTom seems as good a place to start as ever.
- Apple don't need the hardware business: Apple is unlikely to want to get into the satnav business. If they acquire TomTom the hardware business is likely to be sold off (perhaps back to the founders). I don't see this as a stumbling block to the deal. Garmin would be interested at the right price (it would give them a virtual monopoly on automobile navigation), or at the end of the day they could simply shut it down for a minimal loss.
In summary I believe the problems underlying iOS Maps will take longer to fix than the market believes, and people underestimate the hidden value in TomTom's asset portfolio. To me Apple acquiring TomTom makes absolute sense.
Yesterday I set out the strategic rationale for Apple to acquire TomTom. In a nutshell 1) it helps them fix iOS maps, 2) it gives them longer-term muscle in the mapping business and 3) is a do-able deal.
Today I want to focus on the third point - how would the deal come about and how much would Apple have to pay. My key takeaways is that the deal is very do-able, but Apple will need to pay a decent premium to the current share price.
TomTom: A potted history
TomTom: Rise and Fall
Before I lay out my case I want to provide some background on TomTom. This is partly for entertainment value (its certainly been been one of the more eventful companies I've covered in my time as an equity analyst), but mainly because to understand this deal you have to understand where the founders are coming from.
TomTom began as a software shop by a bunch of former employees from Psion's Dutch arm, notably Harold Goddijn and his wife Corinne Vigreux (who still lead of the company today). The outfit - called Palmtopsoftware - originally wrote apps for Psion PDAs. I remember with some affection using their ZX Spectrum simulator on my Psion Revo back in the day (it let you play Defender of the Crown in the college library. 'nuff said). They then moved onto writing apps for Windows CE-based devices such as dictionaries and nagivation apps.
Harold's current yacht
Then engineer (and co-Psion refugee) Mark Gretton struck gold with the idea that rather than kludging their software onto Windows CE boxes, they should build their own dedicated device. This was a classic case of a dedicated appliance pioneering a new technology. TomTom happened to be at the right place at the right time, and smart enough about branding their devices to build a big lead in the market. IPO, riches and acclaim followed. Harold and Corinne bought a yacht.
Then it all went wrong.
Two things (almost) killed TomTom. First they grossly overpaid to buy Tele Atlas funded by far too much debt. Then both debt market and the satnav market crashed.
Actually buying Tele Atlas was a smart strategic move. At the time it was one of only two vendors (along with Navteq) which had a full digital map for Europe and North America (Google has since built its own third map) and thus had genuine scarcity value. And the market for a dedicated appliance matured, it made sense to diversify into higher-margin software. The fact that I am now writing about Apple wanting to buy TomTom - principally for Tele Atlas - is in some ways a vindication of the deal. Unfortunately they made the mistake of getting into a bidding war with rival Garmin which meant they ended up paying €3bn, funded by debt.
They might have survived that but then the global economic crisis hit just as the satnav market went ex-growth. With revenues from its main profit-driver falling at a 20-30% rate TomTom simply could not meet its debt covenants and the shares which had peaked at over €60 fell to less than €3. This culminating in a near-death experience and a rather messy refinancing mid-2009. To their credit Goddijn and Vigreux put their money where their mouth was, putting their personal wealth back into their company via the rights issue. They also brought on-board friendly local investors Janovo and Cyrte who put in €100m for a 10% stake. The current shareholder structure looks like this:
Since then its hardly been an easy ride. In particular Google's bombshell in October 2009 of free turn-by-turn on Android (a move finally followed by Apple this year) was the beginning of the slow death of Satnavs as a mass market proposition. Yes there remains a market for them for holidaymakers or professional users (I actually bought one this year to help navigate us on our honeymoon!), but since then Satnav revenues have declined steadily, such that TomTom no longer even tells us how many devices they have sold each quarter. To her credit CFO Marina Wyatt has done a good job defending margins and keeping the company profitable (the pressure of debt covenants does help focus the mind), but it can't have been much fun in recent years.
But at least they still have the map.
How much is TomTom worth?
There are two questions here. First how much TomTom is worth as a standalone business. Second how much is it worth to Apple.
Actually the first question doesn't matter a vast amount (I know, I know. Any value investors please leave the room now). It gives us a starting point for valuation but everyone at the table will know the real point is how much Apple is prepared to pay. For what it's worth, here's a bog-standard DCF I knocked up on TomTom's business:
Key assumptions are highlighted in blue. I'm not going to claim its a work of art, or indeed that its going to be particularly accurate. Basically IF you assume satnav declines (and therefore revenue declines) bottom out this year AND IF you assume TomTom can sustain a 10% margin then it implies a valuation price a smidge over €4 /share or about €900m for the equity (not far off the current price). . At the DCF valuation TomTom would be trading on roughly 1x EV/Sales and a 10-12.5x forward P/E multiple, consistent with a stable low-growth company. Of course that does assume that Satnavs don't die a death, and that competition doesn't crush margins - as I said its not a work of art.
This isn't particularly useful in figuring out M&A valuation - but at least it gives you a starting point for both sides.
How much is TomTom worth to Apple?
Now we get to the M&A valuation, which is much more interesting but more frustrating. I'm not going to apologise for the fact that the numbers I'm going to talk about here will have little grounding in intrinsic value or sane investment valuation. The sad fact is that most M&A is value destructive, and so the key question is not what an asset is worth but what some mug is prepared to pay for it.
The economic rationale of the deal is simple. TomTom has an asset (its digital map + associated expertise) which it is unable to fully monitise through its existing lines of business (selling satnavs and licencing the map to third parties). However plug that into Apple's front end and distribution and you can suddenly monitise that asset across hundreds of millions of iOS users. Therefore the cash generating potential of that asset is much higher for Apple than for TomTom.
That's the theory. In practice figuring out how much extra value Apple can create over the next 5... 10... 15... 50 years is anyone's guess. At the end of the day it boils down to how much the sellers reckon they can get out of Apple, and how much will make them feel good about themselves. i.e. its an exercise in psychology as much as mathematics.
As with any negotiation, what you need do is put yourself into the shoes of everyone gathered round the table.
Apple: To best honest, they don't particularly care. With $82bn of cash in the bank whatever they pay for TomTom isn't really going to ruin Tim Cook's day. I would say they won't want to pay stupid money for TomTom, and by that I would mean the demonstrably silly €2.9 - 5.7bn price tags which Tele Atlas and Navteq sold for during the last bubble. I would say those levels would be the hard lines which Apple would not want to approach.
Apart from that you can slice the valuation every which way. For example how much more would an iOS user theoretically pay to replace Apple Maps with a decent mapping app? If you assume $5 and multiply that by a 410m iOS installed base you get $2bn (but then again Google Maps is free, and its more about the value of Apple/TomTom maps to future iOS users than existing ones). How much did Apple's share price get whacked by the maps fiasco? $30bn according to some (hint: don't believe everything you read in the papers) so by that reckoning any price tag is good value (the fault in that logic, btw, is that you are making an assumption that TomTom DEFINITELY will map Apple maps as good as Google; it might not).
Another way to think about it is how much would it cost for Apple to build the map from scratch. The short answer is that it took both Tele Atlas and Navteq about $500m of capex to build their US + Western Europe maps back in the 1990s. You could undoubtedly do it for less now (for a start you could buy a TomTom to help your mapping trucks navigate the roads...). But there's a catch - it would take you several years to do this - so whats the opportunity cost of giving Google another few years to forge ahead? Tricky...
We can play these games all day. I think Apple would be willing to pay up to the €3bn level Tele Atlas went for before (they can console themselves that they're getting TomTom's other assets thrown into the deal) which gets us to €13 /share. But I'd assume they'd want to pay far less.
How much will the insiders sell for?
Janovo/Cyrte: This is the easy one. Dutch private equity houses Janovo and Cytre invested €100m in the 2009 refinancing, and hold a 10% stake in TomTom. Doing the math, that means they're currently sitting on a c15% loss on their initial investment. What would be a sensible financial return for them? I think they would want to show their investors at least a 15% CAGR return, and preferably a nice round 20%. Compounding that over three and a half years that would point to a €1.63 - €1.89bn valuation, or roughly €7.4 - €8.5 /share.
In practice though these guys are "friendly" investors for the management. If the founders take an offer they are likely to. And if the founders reject it, the deal is dead anyway.
The Founders: At the end of the day, its whether the four founders Goddijn, Vigreux, Geelen and Pauwels will take a bid. They control 48% of the equity and will have to support any acquisition given TomTom has a poison pill in place to prevent a hostile takeover.
At the very least I think they will want to see a decent return on the €4.21 /share at which they bought back into the company in the 2009 rights offering. It is important to understand the psychology behind this (which is why I gave the potted history above). The founders had nurtured their baby, seen it blossom into a giant and then seen it crash. In 2009 they had the option of walking away and let it get taken over by their debt holders, or putting their money where their mouth was and buying into the refinancing. To their credit they took the latter option, and the company is still around today. But I think the final vindication would be if they could walk away from that investment with a profit.
Another pointer would be stories about a potential de-listing which circulated earlier this year, when the shares were languishing around €3. If they were true (and, to be honest, who bloody knows?), then that would imply the insiders believed the shares were materially undervalued at that level. So what, at least €4 /share perhaps?
But its not just the money. After all in any scenario Apple would have to offer a reasonable premium to the current share price. As I said its important to remember for the founders that TomTom is their baby. So the quality of the offer is as important as the level.
By this I mean if, say, an offer came in from a private equity house which wanted to break up TomTom, fire the employees and sell off its assets it would get very short shrift.
But if an offer came from say a world-beating tech company, famously entrepeneur-led which would allow TomTom to take its navigation vision to another 410m users... Well that would be another story.
And if that gave the founders an opportunity to flourish on a bigger stage. Well...
Somewhere over the rainbow...
As I said, its as much about the psychology as the valuation.
So where have we come out at? I think Apple could pay up to €13 /share, but would want to pay less.
Janovo/Cytre would be looking at in excess of €7.4 /share. The founders would want more than €4.21 /share. The stock is currently trading at €3.86 /share. Standalone fair value (for what its worth) is probably around €4 /share (in my humble opinion).
Oh and one more piece of market nous - when you make a bid you want it to be a "knock-out bid", i.e. not a low-ball offer which makes shareholders hold out for more. In my experience a knock-out bid comes at a 30%+ premium to the share price, preferably a 40%+ premium. Yeah I know - Benjamin Graham would be turning in his grave. But Bruce Wasserstein wouldn't.
That's what they meant when they said valuation is an art, not a science.
Put a gun against my head and I'd say €5.5-8 /share, probably towards the lower half of that range. The key thing would be to get the founders on-board, at whatever price it takes.
Afterword: A few thoughts on deal mechanics
Timing: Given cash resources, and the fact it would be an agreed deal, I think this would be a relatively straightforward transaction. All that would be required would be a public tender for the remaining publicly-held shares. Provided there was a knock-out bid (In excess of 40%-ish to the current share price I don't think there would be much push-back from the other shareholders. I reckon if they did this tomorrow it would easily be wrapped by Q1.
Counter-bids: There isn't an obvious counter-bidder out there either. Microsoft and Google already have their maps sorted out. The other big consumer ecosystem players - Facebook and Amazon - don't has as direct an interest in location-based services. I doubt the business would attract a counter-bid from a financial buyer as it already has a reasonable debt load, and has shown in the past that its model isn't amenable to high levels of gearing.
Regulatory hurdles: The only stumbling block I can think of would be regulators. On the mapping side given Nokia/Microsoft and Google are such powerful and well capitalised rivals I doubt there would be a viable challenge. If there's one thing we're not lacking in smartphones at the moment its competiton! Garmin could potentially mount a challenge on the satnav side, but given Apple has no use for the hardware busineses I think they'd be very happy to divest it. Possibly to Garmin.
Oh and by way of disclosure, no I don't hold any shares in TomTom or Apple. The forecasts (for what they're worth) are my forecasts and the opinions are my opinions. You heard it here first.