It’s true that Microsoft has been working on some kind of deal with Yahoo for the past 18 months now, so it shouldn’t seem like a shock. It’s also true that, before Microsoft’s offer, Yahoo’s stock had been dropping in price; at the original price of $31 per share, Microsoft was offering Yahoo stockholders a 62 percent premium over the recent closing price on the search engine’s stock. Yahoo has taken a beating for the last eight quarters; if the replacement of Terry Semel as CEO with co-founder Jerry Yang will save the company, we didn’t see any signs of it before Microsoft made its bid, at least in the price of Yahoo’s shares.
But that was then, and this is now. Thanks to the stock market’s reaction to Microsoft’s bid, the software giant’s stock has lost 13 percent, while Yahoo’s stock has shot way up, to as high as $29 per share. All of a sudden, Microsoft’s bid doesn’t look so good anymore. Once again adding insult to injury, the dip in price of Microsoft’s stock reduces the company’s value by about $42 billion – or approximately the price that Microsoft wants to tender for Yahoo.
Yahoo thinks that price is way too low. Here is how the search engine’s board of directors explained it in a company press release:
“After careful evaluation, the Board believes that Microsoft’s proposal substantially undervalues Yahoo! including our global brand, large worldwide audience, significant recent investments in advertising platforms and future growth prospects, free cash flow and earnings potential, as well as our substantial unconsolidated investments. The Board of Directors is continually evaluating all of its strategic options in the context of the rapidly evolving industry environment and we remain committed to pursuing initiatives that maximize value for all stockholders.”
That looks like a straightforward rejection, unless you read between the lines. Yahoo is saying that Microsoft’s bid undervalues the company. Does this imply that Yahoo would be open to a larger offer?
Microsoft’s most obvious option – and the one it’s least likely to take – is to take the rejection seriously and walk away. There are several reasons it won’t do that, but Noel at the Search Engine Herald nailed a very important one: “If you think about it, who needs who? On the search front, I definitely believe that Microsoft needs Yahoo more than the other way around.” The London Times stated that “Microsoft is desperate to take over Yahoo! because of the threat that Google’s dominance of the online search advertising market poses to the computer company’s future.”
So what options are left to Microsoft, if it won’t be walking away from Yahoo’s rejection? If the software giant still wants to handle this carefully, it could simply raise its price. And it sounds prepared to do so. In an interview with Advertising Age, Yusuf Mehdi, Microsoft senior VP of strategic partnerships, notes that his company is committed to making the deal work. “Without a question, we are very committed to this combination. … We have a whole set of plans and preparations ready to go to make it work. And we’d like to do that in a cooperative way with Yahoo. No question – our commitment is clear with this one.”
So how much would Microsoft have to raise its bid to get Yahoo to take a look? Well, some analysts have said the software giant might be willing to raise its proposal to $35 or $36 per share, but even that might not be enough. The Times quoted “a source close to Yahoo!’s thinking” as saying a counteroffer “would have to be in the 40s to start talking, and we would have to get over regulatory issues. It would have to be an offer that would give Jerry Yang something to stand on a podium and smile about.”
The third option for Microsoft is to turn it into a hostile bid. That gives the company some interesting paths to pursue, thanks to the timing of their proposal. Yahoo begins its annual nomination process for board elections on Wednesday. It will run through March 14. Anyone who owns stock in Yahoo can make nominations. And – here’s the icing on the cake – all 10 of Yahoo’s board seats are coming up this election.
Bruce Goldfarb, a veteran proxy solicitor, figures that Microsoft is already working toward the goal of getting a favorable slate for itself. “If they haven’t done it already, they’re in the process of assembling an appropriate slate,” he said. “It’s fair to assume they will run for board seats, and it won’t take them long to fill the slate. We’re talking Microsoft here. They have resources and access to countless high-quality candidates to be a director.”
So what options does Yahoo have if Microsoft gets pushy? As with many large companies, it’s widely known that Yahoo has “poison pill” provisions in case of a hostile takeover. These were adopted in 2001. They stipulate that if anyone buys 15 percent or more of Yahoo’s stock in a hostile takeover, then shareholders can buy extra shares, which would dilute stock ownership. Microsoft’s resources are substantial, but they are hardly infinite.
Yahoo could also go to the Department of Justice to complain about antitrust issues and try to stave off the takeover. This has been tried before in other situations. PeopleSoft attempted it five years ago when Oracle targeted the software company for a hostile takeover. The Department of Justice filed a lawsuit in an attempt to block Oracle. Ultimately, it didn’t work; the suit was overruled by a federal judge, and PeopleSoft had to accept Oracle’s $10.3 billion offer in 2004, after 18 exhausting months.
Or Yahoo could seek other partners with whom to merge – someone who’d be a better fit and harder for Microsoft to swallow. The possibility of a deal with Google keeps coming up in the press, despite the anti-trust, monopoly, and regulatory implications. Yahoo is arguably more about content than search, so the idea of it looking to Disney for a deal is not as far-fetched as it might seem at first glance.
Media reporting on Microsoft’s rejected bid usually mention the Disney possibility in the same paragraph as a stronger one: a Yahoo merger or alliance with Time Warner’s AOL. Search Engine Journal notes that “the core to a Microsoft alternative could be that Time Warner is more of an entertainment and content company, fitting the Yahoo model and would give the company the ability to become strong partners with CNN, Time.com, and other Time Warner properties.”
But all of this assumes that Yahoo is really that desperate to get Microsoft out of the picture once and for all. There is certainly a contingent at Yahoo who would fight any Microsoft deal, even to the point of making life difficult for Microsoft after a merger. But there are other forces at work too. Reuters noted that “A dissident group of Yahoo shareholders…launched a campaign to sell their shares as a block. Eric Jackson, leader of a group of shareholders representing less than 1 percent of Yahoo shares, said his group was prepared to negotiate separately with Microsoft or any other bidder.”
There is some debate over how serious a fight Yahoo will put up to keep Microsoft from buying it. Some say that Yahoo’s rejection of Microsoft’s bid is really the search engine’s way of making a counteroffer, and that the two companies will probably settle on a price around $36 per share. One has to wonder, though, whether any deal with Microsoft is a better value for Yahoo’s shareholders.
Cambiar Investors doesn’t seem to think so. They liquidated their holdings in Microsoft when they received news of the company’s proposal to Yahoo. Cambiar president Brian Barish explained that “Microsoft knows even less about the Internet than Yahoo. I can’t see how they can make the business better.” Ouch.
If the potential deal drags out, a lot of Yahoo executives and engineers might leave the company, diluting its value to Microsoft (though there are also rumors that Microsoft is already headhunting over at Yahoo – a consequence, no doubt, of Yahoo’s layoff announcement). Are we dealing with rats leaving a sinking ship?
One has to wonder if they’d be better off – not with Microsoft, perhaps, but with some other company. Bill Houghton at the Brooding Savage notes that Google may be the driving force behind the deal, but a combined Microsoft/Yahoo won’t necessarily be better able to compete. “Both companies are trailing because of poor product portfolios, poor monetization, and a failure to innovate. The combined company…is not much more likely to beat Google.” He believes that Yahoo’s only hope is “a truly innovative product offering. Something that will catapult them ahead of Google, not because it is incrementally better, but because it offers a value proposition that Google cannot match.”
If you consider how much a merger is likely to distract Yahoo and Microsoft from competing with Google, at least for the next couple of years – while Google gets further ahead – accepting even a higher offer from Microsoft could be the final nail in Yahoo’s coffin. Even so, Yahoo may be left with little choice. I don’t envy Jerry Yang right now.