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Microsoft's $20 Billion Bet on Nuance

Microsoft (NASDAQ: MSFT) has been on a yearslong shopping spree, including recent rumors that it is interested in buying gaming chat start-up Discord for over $10 billion. The enterprise software giant kicked off the week by announcing a blockbuster deal to scoop up voice recognition and artificial intelligence (AI) specialist Nuance Communications (NASDAQ: NUAN) for nearly $20 billion. That price tag is second in size only to Microsoft's $26.2 billion acquisition of LinkedIn back in 2016.

With the Nuance transaction, Microsoft is significantly bolstering its position in the healthcare market. Here's what investors need to know.

Microsoft CEO Satya Nadella. Image source: Microsoft.

A "strategic no-brainer" deal

In terms of how the deal is structured, Microsoft will pay $56 per Nuance share in cash, which represents a 23% premium relative to Friday's close. That values Nuance's equity at around $16 billion, but the total price tag increases to $19.7 billion when including Nuance's net debt. Microsoft finished 2020 with nearly $132 billion in cash on its balance sheet, so it can easily afford the purchase while still remaining committed to its share repurchase program. The tech company started a new $40 billion buyback program in late 2019.

Nuance and Microsoft had partnered back in 2019, with Nuance leveraging Microsoft's specialized healthcare cloud. Microsoft says that the acquisition will double its healthcare total addressable market (TAM) to nearly $500 billion while strengthening its cross-industry AI capabilities.

Nuance is already a dominant force in healthcare technology, counting an estimated 77% of hospitals in the U.S. as customers. The company offers a variety of AI-powered services to healthcare providers, including voice transcription, patient engagement, and documentation capture, among others. Nuance also has its flagship Dragon speech recognition software that is used by consumers and enterprise organizations, but the healthcare segment has long been the primary revenue driver, representing roughly 56% of revenue last year.

"Nuance provides the AI layer at the healthcare point of delivery and is a pioneer in the real-world application of enterprise AI," Microsoft CEO Satya Nadella said in a statement. "AI is technology's most important priority, and healthcare is its most urgent application."

Once the deal closes, which is expected this calendar year, Microsoft will include Nuance's financial results in its Intelligent Cloud business. The deal will be slightly dilutive to earnings in fiscal 2022 (next fiscal year), before becoming accretive to adjusted earnings per share in fiscal 2023.

Wedbush analyst Dan Ives called the acquisition a "strategic no-brainer" as Microsoft leverages its strong balance sheet to accelerate its cloud ambitions. Generally speaking, when companies have more cash than they need for operations, they should either return some to shareholders or pursue other productive uses rather than letting it sit idle. In this case, Microsoft can do both, scooping up a highly complementary business while still having plenty of money to fund dividends and buybacks.

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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Evan Niu, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Microsoft. The Motley Fool has a disclosure policy.


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