Why Microsoft — Bing, Xbox & the NBA

Note: I wrote this before President Trump announced that he will issue an executive order banning TikTok effective August 1, 2020. It’s feasible that this is a coordinated tactic that will force ByteDance to lower its asking price, which would let Microsoft purchase TikTok U.S. for a cheaper amount. As of this morning (Aug 1) I believe there is a strong likelihood. UPDATE: As of August 1 at ~10am ET, ByteDance has announced they will now sell 100% ownership in TikTok U.S. Previously, they were only offering 51% ownership. Appears negotiations are working. Microsoft purportedly is holding offer at $30B. ByteDance is asking for $50B. Possible that President Trump’s actions are intended to force ByteDance into a fire sale. Either accept the offer or lose access to the U.S.

Note 2: After discussions with President Trump and ByteDance, Microsoft announced they will not continue pursuing the acquisition.

Disclosure: I own shares in Microsoft. I outlined my bull thesis two weeks prior to this story here.

Two things were notably absent at Wednesday’s Big Tech hearing: the proper pronunciation of Sundar Pichai’s name, and Microsoft.

Even with increased anti-tech pressure in the media and on Capitol Hill, Microsoft has avoided antitrust scrutiny. There are a few reasons for this, one being that Microsoft ‘already experienced that’ in 1998. Still, avoiding this scrutiny is quite valuable, and soon, we might be able to put a price on it. The U.S. operations of TikTok.

See, almost every company at Wednesday’s hearings is salivating at the thought of owning such an explosive application. Facebook would absolutely love to purchase it, but they can’t. Not in today’s environment. Not after they bought Instagram and WhatsApp, and tried to buy Snapchat. Google would love to acquire it, but they can’t either. Not when they are already facing antitrust scrutiny over their handling of Google apps on Android. Apple probably doesn’t want it. Amazon definitely does though, and they have the best shot at getting it, except for the fact that the U.S. government likes Microsoft more. And considering that the U.S. is mandating the selling of TikTok’s U.S. operations, that means the U.S. government’s blessing is the biggest hurdle for this acquisition.

A Social Media Company

In the hour following the news of Microsoft’s interest, questions reverberated around Twitter asking why Microsoft would be interested in doing this deal. Chiefly: Why would Microsoft buy a social media company? Aside from the strategic value, which I’ll outline below, this is an improper framing of TikTok.

TikTok is more a media company than a social media company. It’s primary product is an algorithm that figures out what users will enjoy the most. TikTok is less Instagram, and more YouTube for mobile. For example, when you first download Instagram, Facebook, or Snapchat, you are presented with an empty feed. You have to manually find and add friends before you actually see anything. Contrast that with going on YouTube. You immediately see videos on the homepage, even if you don’t have a google account. Open a private browser tab and see for yourself. Further, once you view a video, an algorithm determines what you’ll see next. YouTube’s algorithms determine what to place in the “What’s Next” sidebar on the right of the video.

TikTok acts the same way. As soon as you open the app you’re greeted with content. No matter who you are or where you are, you see whatever the algorithm thinks you’d like the most. A video might be first shown to only a few people, but if they like it, TikTok’s algorithm shares that videos with 100 people, then 1,000, then 10,000. It executes these tests quickly, meaning that you’ll almost always enjoy what content you see in the app. And it’s inside the app where you notice that TikTok is vastly different than YouTube.

TikTok was built for mobile first and foremost. The most obvious example is that YouTube videos on mobile default to landscape, whereas TikTok videos are in portrait mode (same with Snapchat). It’s a small difference, but it’s one of the reasons why TikTok has exploded in popularity. The app’s interface invites you in, and keeps you engaged. Instead of scrolling through a feed or rotating your phone, TikTok fills your screen with content, and makes new content one swipe away.

And the content is really good. Twitter is text, Facebook is photos, and TikTok is videos. Videos are more engaging. This, compounded with the fact that TikTok is a more mobile-friendly app, means that TikTok is a more compelling mobile experience. This is true for users and creators. YouTube is notoriously difficult to produce content on. You have to setup a camera, plan what you’re going to do, prepare for the video, and then edit it on a computer. It takes quite a while to do all that, and it’s pretty hard. Creators love TikTok on the other hand — TikTok does most of the work. These videos are ~20 seconds long, whereas YouTube videos can be over 20 minutes long. Creating TikTok content is mobile-friendly, which is another way of saying it’s easy.

As a quick aside: this is also why Google is probably seething right now — because this plays so well into YouTube and Search. But, most importantly, TikTok would give Google a successful social app (which they tried, and failed to create, with Google Plus). They absolutely want TikTok, but optics won’t allow it.

Optics, Privacy & Propaganda

Speaking of optics — one of the narratives around Wednesday’s hearings was that American tech companies are too big. Microsoft is considerably larger than Facebook, yet Satya Nadella wasn’t dialing into WebEx on Wednesday. An acquisition of TikTok wouldn’t make Microsoft less powerful. Even so, I see two reasons why Microsoft will be permitted to proceed: 1) the U.S. needs someone to acquire TikTok, and 2) Microsoft has the capital to do it (more on this below).

First, the U.S. government’s primary concern is getting TikTok out of the CCP’s hands. Regardless of your political leanings, it’s worth understanding how TikTok is a national security concern. The best tech analyst in the world, Ben Thompson, wrote a compelling article two weeks ago on this very topic.

First, he detailed TikTok’s privacy policy:

While TikTok claims that it is independent from ByteDance and stores data in the U.S. and Singapore, its privacy policy is clear:

We may share your information with a parent, subsidiary, or other affiliate of our corporate group.

That means that TikTok data absolutely can be sent to China, and, it is important to note, this would be the case even if the privacy policy were not so honest. All Chinese Internet companies are compelled by the country’s National Intelligence Law to turn over any and all data that the government demands, and that power is not limited by China’s borders. Moreover, this requisition of data is not subject to warrants or courts, as is the case with U.S. government requests for data from Facebook or any other entity; the Chinese government absolutely could be running a learning algorithms in parallel to ByteDance’s on all TikTok data…

That, though, is not the primary risk: what should truly concern Americans is the algorithm.

In June, President Trump held a rally in Tulsa, Oklahoma. The turnout was far-smaller than anticipated. The New York Times suggested that TikTok might have played a role:

TikTok users and fans of Korean pop music groups claimed to have registered potentially hundreds of thousands of tickets for Mr. Trump’s campaign rally as a prank. After the Trump campaign’s official account @TeamTrump posted a tweet asking supporters to register for free tickets using their phones on June 11, K-pop fan accounts began sharing the information with followers, encouraging them to register for the rally — and then not show.

Ben continues:

There is no way we can know for sure, and, to the extent that TikTok actually did have an impact on the rally, that should frighten people of all political persuasions.

After all, this certainly wasn’t the first time that TikTok has seemed to act politically: the service censored #BlackLivesMatter and #GeorgeFloyd, blocked a teenager discussing China’s genocide in Xinjiang, and blocked a video of Tank Man. The Guardian published TikTok guidelines that censored Tiananmen Square, Tibetan independence, and the Falun Gong, and I myself demonstrated that TikTok appeared to be censoring the Hong Kong protests and Houston Rockets basketball team.

The point, though, is not just censorship, but its inverse: propaganda. TikTok’s algorithm, unmoored from the constraints of your social network or professional content creators, is free to promote whatever videos it likes, without anyone knowing the difference. TikTok could promote a particular candidate or a particular issue in a particular geography, without anyone — except perhaps the candidate, now indebted to a Chinese company — knowing. You may be skeptical this might happen, but again, China has already demonstrated a willingness to censor speech on a platform banned in China; how much of a leap is it to think that a Party committed to ideological dominance will forever leave a route directly into the hearts and minds of millions of Americans untouched?

I urge you to read the rest of his piece.

This is why the U.S. government doesn’t care if Microsoft gets larger. It’s a secondary issue to their main concern. Whether or not you agree with the prioritization, you have to understand the framework they’re using. And(!) Microsoft wasn’t at the hearing on Wednesday, so optically, this isn’t as bad for the U.S.

However, that also begs the question: If we don’t want Big Tech doing it, who else could acquire TikTok?

Other Contenders

Disney was the first company that came to mind when I first read the then-breaking news. But, like Facebook, Google, and Amazon, it can’t do it right now. Just for different reasons.

Prior to COVID-19, Disney already had debt-to-assets ratio of 27% (a 10-year high). Disney assumed Twenty-First Century Fox’s long term debt following the close of its acquisition; as of October 2019, Disney had $53 billion in debt. Fast forward to 2020, and Disney has been hammered by COVID-19. In fact, it had to raise an additional $11 billion in debt in May. It’s hard to see Disney raising additional capital to meet the reportedly ~$50 billion that ByteDance (TikTok’s parent co) is asking for, especially since Disney only had $14.3 billion in cash on hand as of March 2020. There’s also the fact that TikTok’s U.S. CEO, Kevin Mayer, is a former Disney executive. You could either argue that helps or hurts Disney’s chances. Either way, it’s possible, but unlikely.

Berkshire Hathaway has the cash on hand, but if Buffett wasn’t willing to invest in Microsoft when Bill Gates offered to walk through the business with him, then I doubt he’d be interested in learning about TikTok.

Sequoia Capital, the distinguished venture capital firm that invested in Airbnb, Apple, Google, PayPal, Stripe, Zoom, and many more, is also in discussions with TikTok. This is more interesting, since Sequoia (and potentially General Atlantic) would be increasing their ownership in order to gain control, instead of an outright acquisition (though discussions may have evolved). From my knowledge, this has never happened before, and would potentially mark a VC firm making its first leveraged buyout. Regardless of its historical precedent, I’m unconvinced this would be pan out. Sequoia does not have operating experience, and this isn’t a simple acquisition. Splitting U.S. TikTok off will require considerable technical prowess, but also impeccable execution. It also might be hard to convince the U.S. government Sequoia’s our best option, even if Sequoia gets total ownership.

The only other potential would be a SPAC or Large-Cap Private Equity firm; as I mentioned, this is going to be an incredibly technical lift. Financial engineering will not succeed in decoupling TikTok U.S. from TikTok Rest of World.

At the end of the day, the U.S. government would rather have a tech company do the acquisition. Normally that wouldn’t mean a lot in a sale process, but this isn’t an ordinary auction. The fact of the matter is that aside from Big Tech, not many companies would be interested in TikTok, and the ones that are interested aren’t doing well because of COVID-19. Microsoft on the other hand, has done very well.

Bing, Xbox & the NBA

To understand the TikTok deal, we need to revisit an announcement Microsoft made in April 2020.

The National Basketball Association (NBA) and Microsoft today announced a new multi-year collaboration, which will transform the way in which fans experience the NBA. As part of the collaboration, Microsoft will become the Official Artificial Intelligence Partner and an Official Cloud and Laptop Partner for the NBA, WNBA, NBA G League, and USA Basketball, beginning with the 2020-21 NBA season.

It gets more interesting though (emphasis mine):

Microsoft and NBA Digital will create a new, innovative, direct-to-consumer platform on Microsoft Azure that will use machine learning and artificial intelligence to deliver next-generation, personalized game broadcasts and other content offerings as well as integrate the NBA’s various products and services from across its business. The platform will reimagine how fans engage with the NBA from their devices by customizing and localizing experiences for the NBA’s global fanbase, which includes the 1.8 billion social media followers across all league, team and player accounts.

Beyond delivering live and on-demand game broadcasts through Microsoft Azure, the NBA’s vast array of data sources and extensive historical video archive will be surfaced to fans through state-of-the-art machine learning, cognitive search and advanced data analytics solutions. This will create a more personalized fan experience that tailors the content to the preferences of the fan, rewards participation, and provides more insights and analysis than ever. Additionally, this platform will enable the NBA to uncover unique insights and add new dimensions to the game for fans, coaches and broadcasters. The companies will also explore additional ways technology can be used to enhance the NBA’s business and game operations.

Doesn’t this sound familiar?

Now, if Satya Nadella and Microsoft had TikTok in their sights back in April, then I have to hand it to them: their corporate dev team is incredible. However, I suspect this is Microsoft being opportunistic. That doesn’t mean this acquisition wouldn’t benefit their existing strategy though. In fact, it’s a recommitment to Nadella’s vision for Microsoft.

Before we dive further into this NBA announcement, let’s take a step back and examine what exactly Microsoft has been doing the past few years.

Ever since Satya became CEO in 2014, Microsoft has aggressively pursued enterprise offerings in AI and cloud computing. Microsoft has always shown strong research and development (R&D) spending, but since 2014, Microsoft’s R&D spending has grown at a compounded annual growth rate of 9.17%, from $11.4 billion in 2014 to $19.3 billion in 2020. What’s interesting though, is how they break it out. From their 2019 Annual Report (emphasis mine):

We develop most of our products and services internally through the following engineering groups.

  • Cloud and AI, focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services for enterprises.
  • Experiences and Devices, focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Enterprise Mobility and Management, and Surface.
  • AI and Research, focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, applications, and search.
  • LinkedIn, focuses on our services that transform the way customers hire, market, sell, and learn.
  • Gaming, focuses on connecting gaming assets across the range of devices to grow and engage the Xbox Live member network through game experiences, streaming content, and social interaction.

The first bullet speaks to Azure. Azure’s ascendency as the second largest cloud provider, behind Amazon’s AWS, displays Microsoft’s ambitions for all of these R&D segments. It also illustrates that Microsoft has heavily invested in AI, and succeeded in winning contracts because of their capabilities. Capabilities which lends itself quite well to managing TikTok’s algorithm.

The third bullet speaks to the Base Case outcome for the TikTok acquisition. Microsoft already has a profitable advertising business: Bing. While not perfectly aligned to TikTok’s model, this demonstrates Microsoft has a successful track record here. We could end this essay here by saying that Microsoft has advertising and algorithm experience, and the U.S. would be happy because it would add a third competitor to the advertising duopoly of Google and Facebook. The U.S. ‘domesticates’ TikTok, Microsoft has a financial reason to do it, and we get more competition. Everyone wins.

This lacks imagination though. It’s a bleary view of what could be a monumental deal. After all, guess who ran Bing a few years ago? That’s right, Satya Nadella.

Satya recognized Bing’s value to Microsoft’s overall strategy. Notice how search is paired with AI and Research above. Search is hard to execute, and Bing succeeded in its objective. This drove advancements in AI and machine learning used in Azure, Windows, Office, Cortana, and Xbox. Which leads to the less-discussed, but just as important aspect of Microsoft’s strategy.

Microsoft is also a media company, and a widely successful one at that. Xbox Game Studios houses 15 subsidiaries. You may have heard of some of their games: Halo, Gears of War, Forza Motorsport, Age of Empires, Sea of Thieves, and of course, Minecraft.

Microsoft’s gaming strategy warrants its own essay, but in short, their lofty ambitions are starting to materialize. Which points me to two other pieces of news that came out today in conjunction with the TikTok news. First, a verified Xbox account appeared on TikTok.

Verified Xbox TikTok Account: ‘demoo’

As of writing, “Demoo” appears as the name. So either TikTok was really eager in getting this up, or someone is trolling. But Xbox did release news today as well: Halo Infinite will launch with free-to-play multiplayer.

Halo Infinite is free-to-play

Microsoft is making Xbox more approachable, which means more users, and more user generated content (UGC). Just like another app…

Now let’s return back to the NBA. When Ben Thompson covered this announcement, he specifically pointed out how Xbox, and its technologies could “really make this effort sing.” Xbox had over 65 million monthly active users in September 2019. That figure almost certainly went up during COVID-19. And while most people are talking about Fortnite and Roblox (understandably), Minecraft continues to thrive, with over 129 million monthly active users. Fortnite and Roblox have promoted the social aspect of gaming. Minecraft has done this for years too, but in a more refined manner.

So why does this matter? Like sports, gaming highlights are incredibly popular on YouTube, and they’re both popular on TikTok as well. This would be a nice way to promote Xbox, but I think China gives us an even better understanding of where this could go. In China, ByteDance has started displaying advertisements for its own games in TikTok to encourage users to try them. These ads push users into high-margin games ByteDance profits from. Microsoft could do the same thing with its Xbox Game Studios, and promote Halo, Minecraft, and Forza within TikTok U.S.

And, you’ll be able to play those games on any device because Microsoft is rolling out its game streaming service, Project xCloud, this fall. Instead of seeing an ad for Forza for PC, you can watch an ad, and immediately try the game out on your phone without leaving the app. You could record gameplay and share it while you’re playing. Or, you can watch other player’s clips. Like TikTok, Xbox’s mobile-friendly UGC would explode. This isn’t far-fetched either. Facebook Gaming will do this (with xCloud). Google’s Stadia also had similar integration with YouTube when it announced its game streaming service last year. TikTok is the perfect YouTube replacement for Xbox. Especially since Microsoft had to shut down Mixer (a Twitch competitor) due to low usage. In fact, the last bullet point from the R&D excerpt above identifies both xCloud (streaming content) and UGC (social interaction)! Streaming and social both increase margins over time. Something Microsoft and TikTok are pursuing.

xCloud running Halo | Source: TheVerge

This leads us to the NBA announcement excerpt. Like TikTok and Xbox, the NBA also generates content. But for the majority of NBA fans that live outside the U.S., consuming content is hard. This is where Microsoft, and specifically, TikTok, could shine. The NBA tasked Microsoft with delivering the right content, to the right user, at the right time. Microsoft’s expertise in cloud and AI, the same expertise that would enable it to succeed in managing TikTok, will change how sports are consumed. In conjunction with his article, Ben Thompson interviewed Satya Nadella and NBA commissioner Adam Silver. Adam’s comments specifically highlight the NBA’s vision for this partnership:

I think it’s still largely a one-to-many experience, in that there’s very limited customization, and we know that from our fans that they are interested in particular teams, particular players on particular teams, combinations of players that may cross over many teams, or specific aspects of the game, and that we generally don’t have the ability to do that now. Our direct-to-consumer relationship largely revolves now around a website and a delivery system, over-the-top for bringing broadcast game, streaming games to people around the world. But we’re fairly limited in terms of artificial intelligence, understanding what fans really want, customizing the program to their needs, customizing highlights especially.

Ben adds to this vision:

So I think there’s an obvious play here about the personalization, the AI, I’m sure Satya, you would want to speak to that, but I think about this idea if you’re doing a one-to-many model, that’s where the NBA came from, and wants to embrace the fact that you can basically connect with individual consumers and they can get exactly the content that matters to them that is special to them, that’s compelling in part.
But if you go to being a platform, that’s still a broadcast model, it’s more of an individualized broadcast model. Could there be other parts like more of a social model, like you can have different shared experiences with fellow fans or with other people watching a game, I think people in quarantine right now wish they could watch an old playoff game together at the same time and sync up the start and talk about it, etc, or even remix your content.

To which Adam replies:

One of the things we thought about from a technology standpoint is if maybe that it is a unique experience to be in an NBA arena, but the next best thing is to in essence sit down to watch a game, Xbox-like maybe with your headset on, and you have a friend on your left, a fan on your right and it’s just as if you were in the arena talking to those friends during the game. And then maybe also rather than limiting yourself to the 19,000 people in the arena with you, this global community of NBA fans is all coming together in real time, and there’s a way where you’re getting sort of instant wisdom of the crowd in terms of whether they think it was a good call or a bad call or they’re cheering or they’re jeering or whatever is going on.

Satya then details the technical aspects of the project, and almost all of them come from Xbox. Specifically, the RL-based Azure engine for Xbox will be used to drive the personalization. LiveOps, another component which came out of Xbox, will let the NBA build the second screen and the social dimension. And they’re all driven by what you’re watching, who you are, and whom are you watching with. In a way, Satya emulated Amazon by incubating Xbox, Azure, and xCloud, and offering them as services once they are ready. Satya summarizes that it’s “the Xbox Live experience for the NBA.”

This enumerates the Penultimate Case for the TikTok acquisition: Microsoft is building its own content (Xbox games), and licensing out the systems it uses to distribute that content to users (cloud apps, streaming, and AI). They’re creating an Azure for content creation, and content delivery. The NBA is the first customer. It wants apps filled with endless highlights of fans’ favorite teams, players, and moments. It just so happens that TikTok has this functionality right now. Being able to immediately use it would dramatically accelerate Microsoft’s timeline. TikTok doesn’t just give Microsoft an advertising business to parlay with Bing, it enables a host of new features to build out a system for content creation, delivery, and consumption (not to mention the ~80 million U.S. users already using the app). TikTok is the mobile app that would connect to all the backend work Microsoft has already started.

TikTok represents a golden opportunity for Satya to cement Microsoft’s stature as a enterprise services company. The NBA is the first of many media companies that will shift to a direct relationship with its customers. It only makes sense that as this shift happens, Microsoft steps in to provide the services to create and deliver customized content to consumers. Ben synthesized this very idea back in April:

Switching from being a studio where you make content and give it to anyone that’ll buy it, to ideally being more of a Netflix where you own the customer and have a direct connection, that customer relationship is the future for media companies generally. It makes sense to see the NBA moving in that direction.

It makes sense for Microsoft too. Both to create the tools for its own media arm (Xbox), and then to offer these tools as services to enterprise customers. Media companies want to build a direct relationship with their customers. Microsoft will help them do so. TikTok is one way to get there.