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The Surprising Synergies of Intel-McAfee

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Intel’s August announcement that it was acquiring McAfee was greeted by head-scratching and primarily negative comments. Observers questioned how Intel could help McAfee grow fast enough to justify the $7.7 billion acquisition price.

But a closer look shows that Intel could do very well from the deal even if its new McAfee division stagnates. The key to success or failure is not what Intel can do with McAfee’s software business, but what McAfee can do for Intel’s chip sales, and if the company can craft new security solutions that span software and processors.

Where are the ynergies?

Let’s look first at Intel’s options for its new McAfee division, and then at the potential effect of the acquisition on Intel’s other businesses.

Common wisdom says that companies making large technology acquisitions pay a price in terms of loss of focus in the acquired organization, defections of key employees, diminution of entrepreneurial drive, and loss of visibility in the marketplace. These penalties must be offset by synergies and cost savings for the acquisition to be successful.

Most analysts and journalists have noted the apparent lack of synergies from folding McAfee into Intel. There is little overlap in research, production or distribution. The sales forces sell to different buyers. McAfee is already large enough so it will hardly benefit from Intel’s brand recognition and financial backing. Consolidating administrative functions won’t come close to justifying the 40 percent premium that Intel paid for McAfee’s stock.

Whither McAfee?

So what strategies could Intel pursue for its McAfee division?

It could try to milk McAfee’s customer base by increasing maintenance prices and cutting back on R&D. But while this approach might work with a distressed company acquired on the cheap, it doesn’t make sense when the acquirer pays a large premium.

Intel could go to the other extreme. With $18 billion in the bank it could make McAfee the core of an expanding IT security and systems management empire. But this is a risky strategy, since Intel would have to acquire more security companies at premium prices and accept the challenge of integrating them into a growing McAfee division.

The most likely outcome is that Intel will continue to operate McAfee as a free-standing division, but that the growth trajectory will be somewhat lower than what would have occurred if the company had remained independent. This means that the McAfee division by itself is unlikely to throw off enough cash to justify Intel’s purchase price.

But before we decide that Intel has made a colossal error, let’s conduct a little thought experiment about the impact McAfee’s technology could have on Intel’s chip business.

A back-of-the-envelope calculation

Suppose for a moment that by adding McAfee’s security technology to its microprocessors Intel could boost its chip sales by $1 billion (3 percent of its 2009 revenue of $35 billion). Based on Intel’s margins in 2009, that would generate $560 million in incremental gross profit and operating profits of $163 million.

McAfee’s operating income in 2009 was $223 million. Let’s say that negative effects from the acquisition caused that figure to fall 20 percent next year, to $178 million.

Then Intel’s operating income from incremental chip sales plus its McAfee division would be $341 million ($163 million plus $178 million).

That is 153 percent of McAfee’s operating income in 2009, which would seem to justify the 40 percent premium Intel paid for McAfee’s shares.

This is a very crude calculation, but it illustrates a point: because Intel is 18 times larger, a modest boost to Intel’s revenues (in percentage terms) can swamp changes on McAfee’s side.

What can Intel do with McAfee’s technology?

But is it reasonable to think that technologies from McAfee could increase Intel’s existing businesses $1 billion or more? Absolutely.

Intel can put virus signature processing directly on chips or into firmware to speed up processing. This would produce anti-malware solutions with strong competitive advantages over software-only products.

Other major security technologies also utilize intensive calculations for signature matching and pattern recognition. Moving this processing to hardware could result in superior firewalls, intrusion prevention systems (IPS), and data loss prevention (DLP) products. McAfee has products in all of these categories.

Security-related information and programs stored on chips are much harder for hackers to crack than the same information and programs stored on disk. Candidates range from serial numbers, to passwords, hashes and encryption keys, to programs that check the integrity of the operating system and software applications on the system. Intel already has products in these areas whose development might be accelerated with additional know-how from McAfee.

There is also potential for new businesses. For example, the effectiveness of information security products depends on how fast and reliably signatures, patches and blacklists can be distributed. Because it controls the “platform” underlying many endpoints, Intel could create a security software distribution and management service with considerable advantages over software-only competitors.

Not just PCs and servers

Intel has already made it clear that it wants to play a role in security for “a vast array of Internet-connected devices.” These could include smart phones, networking and communications devices, televisions, medical and industrial equipment, and even home appliances. Any device with intelligence is potentially a target for hackers, and therefore in need of security. So security technology could give Intel an edge in selling chips to several rapidly growing multi-billion dollar industries.

Intel has structural advantages

Intel also has some interesting options for business models that cannot easily be replicated by competitors. The company could offer some free security capabilities on chips. That would undermine the McAfee software business to some extent, but give Intel an edge over competitors in the chip business. Alternately, the company could continue to sell McAfee security software at current prices, but pump up the software business by making that software work better with its chips; a strategy that rivals could not easily match.

In effect, by creating security solutions that span software and processors, Intel can deploy a “silicon and bits” strategy against “bits-only” competitors. This is somewhat like the retailers with extensive store networks employing a “clicks and mortar” strategy against online firms.

Intel also enjoys an unusual strategic position. When companies acquire a firm in an “adjacent” technology market, they often offend current customers and business partners. We can see what Oracle’s acquisition of Sun is doing to its long-standing relationship with Hewlett Packard.

But in this case Intel has been able to make a major acquisition without negative effects on its primary customers, the PC, server and device manufacturers.

At the same time, there is no effective way for security software vendors like Symantec or Trend Micro to retaliate against Intel for favoring McAfee products. And because it enjoys such an imposing position in the microprocessor market, a countermove by AMD or another chip manufacturer, say a partnership with Symantec, would only partially counteract Intel’s advantages.

Many “ifs” but big potential

Intel and McAfee must overcome many technical and business challenges to prove that it makes sense to pack more security technology onto chips, and that a “silicon and bits” approach really provides advantages over established software-only products. These are not givens. And innovations could come along that render obsolete McAfee’s technologies.

But our discussion should make clear that this purchase is less about what Intel can do with McAfee than what McAfee can do for Intel. And a close look shows that there are indeed clear paths toward making this acquisition a major financial and strategic success.

Security software companies should keep a close eye on Intel’s progress. If the “silicon and bits” strategy starts to pay off, they might want to form partnerships with chip or hardware vendors to counter Intel’s threat or to leverage the same model.

Jon Friedman is president of Product Marketing Services, a company that provides positioning, collateral development and lead generation services to technology companies. He has over 20 years of experience in marketing and business planning with Fiberlink Communications, Astaro, ePresence/Banyan Systems, EPiCON, Wang and Unisys. Email Jon at jfriedman@prodmarketingservices.com.

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