Update: We posted this last night. Since then, Softbank says “thanks, but we’ll pass, too.” Perhaps it’s not a coincidence that Yahoo!’s Board will make its call today, supposedly.
Softbank owns 3.9% of Yahoo! US, and it owns 40% of Yahoo! Japan. Yahoo! owns 30% of Yahoo! Japan.
Yahoo! - via Yahoo! Japan and Alibaba (in China) - is much better positioned in Asia than Google is. Asia is the world’s fastest growing online ad market. PriceWaterhouse Coopers pegged Asia to become a $110B market. I found that suspicious and have tried in vain to get a clarification on that figure, but the point is: Asia will be huge.
As a Yahoo! shareholder, I welcome the initial MSFT bid for $31/share, but I realize it won’t be the final acquisition price, but the initial volley. I think Yahoo! will be sold to Microsoft for something in the $50B market cap price tag. With roughly 1.25B shares outstanding, that’s a $40/share price.
One reason for this is my loss of faith in Yahoo!’s management, and the lack of options.
- Private equity can’t make this deal add up.
- Time Warner is trying to unload AOL and saddled with debt.
- GE welcomes a MSFT/YHOO deal as its NBC unit partners currently with MSFT.
- AT&T has no business owning YHOO.
- eBay is too small.
- News Corp. gets $900M guaranteed from Google, why bother to own YHOO and dilute by 50%.
- Walt Disney can’t afford.
- Neither can CBS or Viacom.
As you go through the potential fits, you realize MSFT is in the pole position. Much like a Formula 1 race, this is MSFT’s race to lose.
Of course, Softbank is a player here. Softbank’s CEO Masayoshi Son is one charismatic and driven fellow. At one point during the bubble, his 53% stake in $160B Softbank made him worth $80B. Today, he’s worth $7B but Softbank remains Asia’s most valuable company. Son’s goal is to make Softbank the world’s biggest Internet company in 1 or 2 decades on the heels of Asia’s growth.
To a North American vantage point, it sounds crazy, but to someone like Son, it’s a matter of time.
I’ve lost faith in Yahoo! management, but not in Son. There are no guarantees of anything happening, but “the talks have just started,” said Son at a news conference where Softbank reported a fourfold surge in earnings.
Revenue related to Softbank’s one-third stake in Alibaba was a major boost to its October-December profit, lifting it by more than sixfold to 46.73 billion yen ($438.8 million) from 7.49 billion yen. Softbank booked a 57 billion yen ($535.2 million) one-time gain from the listing of affiliate Alibaba.com Ltd. in Hong Kong.
For the first nine months of the fiscal year, Softbank’s profit rose dramatically to 93.20 billion yen ($875.1 million) from 21.93 billion yen the same period the previous year. Nine-month sales rose 13 percent to 2.059 trillion yen ($19.33 billion).
When asked directly about MSFT and YHOO, he added:
“We need much more exchange before coming to a final decision.”
Softbank, which has built its Internet empire through acquisitions, bought Vodafone’s Japan unit for $15 billion in 2006.
While Softbank alone cannot match MSFT’s firepower, Son’s creativity and dealmaking acumen should not be underestimated.
In fact, Son has in the past managed to line up banks to his side. Furthermore, indeed while credit markets remain spooked as a result of the housing market, in Asia, the appetite for growth remains as fierce as ever.
It’s worth noting that all of the US-based financial giants have sold shares to foreign institutions in the past few months…
- Citigroup sold a 4.9 percent stake to Abu Dhabi’s investment arm
- UBS sold stakes to the Singapore government and an unidentified Middle Eastern investor
- Morgan Stanley sold a 9.9% stake to China Investment Company for $5B
- Merrill Lynch sold a stake to a Singapore fund.
so just because American Finance is trigger shy does not mean that their counterparts abroad are too.
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WatchMojo NewsletterMarketwatch’s David Callaway suggests that a MSFT acquisition of Yahoo! will be awfully reminiscent of the Time Warner AOL merger, which has left AOL confused and searching for a strategy, as we outlined earlier today. He says:
Microsoft’s bold, $44 billion bid for Yahoo bears many similarities to Time Warner and AOL. Yahoo is a sought-after portal, perhaps the most famous and certainly the sexiest of the mighty three, which include AOL and MSN.com. Microsoft, despite its MSN service, is a mature company; not quite old media, but close. Any combination would involve thousands, if not tens of thousands, of layoffs as the dreaded “cost synergies” were hunted down. For these types of deals only work, to the extent that they ever do, with ruthless cost-cutting.
The big difference is that when Time Warner bought AOL, the Web portal was at the top of its game. Yahoo was also at the top of its game back in 2000, while Google was only just getting started, two years out of Stanford and a full four years before its massive IPO. Now Google trumps both Microsoft and Yahoo, and Yahoo has been looking for direction for most of the last four years.
On a superficial level, Time Warner + AOL is indeed similar to Microsoft + Yahoo!
But the instant you dive into the matter, you realize they’re not identical at all. The outcome might be the same, it might be very different, but going into the deal, the differences far outweigh the similarities:
1) Tech & Media = Oil & Vinegar
Time Warner’s sale to AOL was a big bet on the promise of synergies between technology and old media. In theory we all expect that to work, but between cultures and DNA, it does not always bode well.
Tech and media do make an interesting mix, but they don’t really blend well together, causing problems.
In MSFT’s bid to acquire Yahoo!, a technology-company with a legacy of prowess on the desktop is attempting to acquire a technology cum media company with prowess in online advertising and the Internet. Sure, in many levels, MSFT and Yahoo! are very different, but juxtaposed to Time Warner and AOL, MSFT and Yahoo! are eerily identical (one-time technology giants undergoing some kind of innovator’s dilemma).
2) Deal Structure
More importantly, and this is key to remember:
AOL (a company founded in the 1980s) bought Time Warner (Warner Bros.’ lineage goes back to 1912). That in itself is meaningless, fine, but ultimately, AOL bought Time Warner with an inflated stock as a hedge against the impending dot com bubble bursting.
Steve Case hedged himself using Time Warner: a mature and stable enterprise with much more revenue. In doing the deal (in the 2000 mindset of growth over income), he pummeled his stock overnight but secured his company because the dial-up business would be dying as broadband prevailed.
You might be thinking: so what? The stock market is always right. All right, well, numbers don’t lie:
Before the merger, TW was valued at 20x its annual cash flow. If you applied this to AOL, it would have been worth $30B. Even by today’s standards this would be rich (Yahoo! was worth less than $30B before MSFT’s unsolicited offer), but AOL was being valued at $150B!
To put things into context, today Google is worth $157B (down from its $225 high back in Q4 2007).
When AOL bought Time Warner, it was a $164B merger, created out of thin air, built on sand… and like a house of cards, the whole thing went tumbling down once the Nasdaq market crashed and fell from 5,000 to 1,200 in a few years.
AOL leveraged its balance sheet to acquire Time Warner to spruce up its income statement.
Indeed, Rupert Murdoch said of Steve Case’s deal: “It was brilliant, he bought something with $6B in annual cash flow”.
The problem was the main asset that was leveraged was goodwill. Before long, AOL would have none left, both with analysts, investors, but most importantly, with Time Warner brass.
3) Climate
2008 has gotten off to a shaky start, but broadly speaking, it’s nothing like 2000, which was the tail end of:
a) a 19-year old Bull Run (briefly interrupted by Black Monday in 1987)
b) a torrid 6-year technology boom (the famous “irrational exuberance” call came from Alan Greenspan in December 2006, the valuations of firms like MSFT, Cisco, Dell, and the Web companies continued undeterred all the way until 2000)
c) a bubble era launched by the world wide web’s explosive and speculative growth, driven largely by Yahoo!, Amazon.com, eBay and of course, AOL.
In 2000, we were way beyond irrational exuberance and well into madness. For example, on the day of its IPO, Priceline had a greater market capitalization than the sum of the market cap of United Airlines, Continental Airlines and NorthWest Airlines. On IPO day, Priceline was losing $3 for every $1 it earned! Today, Priceline is worth $4B but it generates well over $1B in revenue and nets $100M in profits.
But no need to get into the outliers like Pets.com and Webvan, AOL had no business being valued at $150B, but it was, and invariably, Steve Case showed his shrewdness by buying Time Warner.
The climate is vastly different because online advertising is a global $40B business expected to grow to an estimated $80B size within a few years. Online advertising is not a gimmick anymore, global marketers and Fortune 500 advertisers understand that online (digital/interactive) advertising will be leading all marketing initiatives and Microsoft does not plan to let Google become a bigger business than it the way that MSFT surpassed IBM and all startups eventually take over the incumbents.
4) Culture
If Steve Case was shrewd, then many felt that his counterpart at Time Warner, Gerry Levin, was plain dumb. Of course he wasn’t. While many media moguls like Rupert Murdoch stayed on the sidelines, players like Levin envied the multiples and media attention the Internet companies got, and eventually gave in to temptation by merging their shops with Web giants.
And make no mistake about it: in 2000, AOL was a giant. But within months, it became vulnerable with the stock market crash. Eventually, Time Warner AOL dropped AOL from the corporate namesake, and took a $99 Billion charge. Time Warner shareholders lost $100B in value. Today TW is worth $55B. The merger pegged the value at $164B. That kind of animosity does not go away.
Even if MSFT/YHOO becomes 1/10th of what the planners are thinking it might be, neither MSFT nor YHOO will lose $100B in market cap. Given the climate, the technology pedigree and the deal structure, it’s hard for this union not to work, especially when both companies are being kicked in the rear end by Google.
This is probably an under-estimated nuance. If MSFT prevails in buying Yahoo!, some staffers will be laid off, many will be reassigned, but anyway you dice it, the stronger company with more revenues, profits, execution track record, etc. is buying the weaker company.
To conclude, Yahoo! has no one to blame but themselves. They are being taken over by a stronger company, mainly because that is how the stock market works. This is as much of a case study on stock market mechanics and dynamics than it is about technology and media, software and advertising.
In that sense, yes, this does remind us a bit of AOL, that was also a manifestation of financial engineering, but apart from that little similarity, the difference far outweigh the commonalities.
As I said, this is all going into the deal, a deal that has yet to be approved.
I think given where online advertising is today, how badly Yahoo!’s management has fared over the past 5 years, Yahoo! should be welcoming this interest from Microsoft. Incidentally, this is one more difference between the two cases. When Time Warner agreed to sell, I suspect a lot of the TW brass was into AOL. In Yahoo!’s case, the board, management and employees seem to be giving the acquiring party the cold shoulder. Maybe that is the best omen yet.
Raise your hand if something got lost during the Time Warner AOL conference call (right, they dropped the AOL brand from the corporate namesake).
I respect Time Warner as a company and they have some very smart people, but I don’t get a sense that they know what they are doing. Actually, I don’t think they know what they want to do.
Time Warner Chairman and CEO Jeff Bewkes said AOL is “open to any strategic moves that make sense” but he feels confident about AOL’s ability to compete.
According to WSJ: in 2007, AOL generated $1.251B in revenues (a drop of 32%!) and $381M in profits.
According to Forbes: AOL remains highly profitable, having posted $1.84 billion in adjusted operating income before depreciation and amortization in 2007, up from $1.77 billion in 2006.
Either way…
The stock is at $15.50, or a market cap of $55B. The 52-week high is $21. Let’s not even mention its all-time high.
The many choices these days include:
- selling AOL - but to whom?;
- selling or spinning off the Platform A (the network that encompasses Advertising.com, Third Screen Media, Quigo, etc.);
- getting out of the access business (subscription for web access).
Bear in mind, this is all coming ten years after the disastrous AOL acquisition of Time Warner. That’s right, AOL acquired Time Warner in January 2000 and since then, the merged entity has been one big pile of disarray soup.
In the past, I argued against a Yahoo!/AOL merger because, for lack of a better term, Google could cock-block it. Google had invested $1B for 5%, valuing AOL at $20B. My argument was simple: any time Yahoo! and AOL got talks going, Google would butt in, show interest, get a price war going and then Yahoo! would back off, as would Google. I apologize for the “cock-block” term here, but I was scratching my head thinking of a better way to coin it.
I think the AOL/GOOG deal set the stage for MSFT to acquire Yahoo! and doomed any shot AOL had of reclaiming its glory of days gone by. If you disagree, I welcome your suggestions.
Incidentally, I recently suggested (before Microsoft’s unsolicited offer for Yahoo!) that Yahoo! should bundle its ad networks and spin them off, to raise $1-4B and unleash shareholder value. Anyway, now that Microsoft has set its sights on Yahoo!, Google feels threatened, Yahoo! feels like it’s on borrowed life, and Time Warner wants to burn any vestiges of its AOL days away.
Time Warner’s main concern, frankly, is its debt level. The company has $37B in debt. That’s a lot of debt to finance. Its cash hoard is less than $2B. In other words, any deal or solution would have to entail a sizable injection of cash.
It’s hard to come up with a strategy for AOL when parent Time Warner itself does not know what to do with the Web going forward. It has bought a lot of business, but I think the answer comes from looking at Time Warner.
Time Warner is a media company. Yes, it owns AOL and Netscape, along with numerous ad networks, but at its core, it is in the content and media business. So here’s what I think Time Warner should do:
Step 1 - Get out of the Access Business
One company that has come up is Earthlink. I don’t think Earthlink makes sense. Earthlink has a $800M market cap. AOL’s access business can fetch $3-5B. I think AT&T or Verizon would make a nice home and they can afford it. AT&T and Verizon are gatekeepers to the digital world, they would know what to do with AOL’s access business. They can also afford it. A cash deal of $3-6B could help pay down some of Time Warner’s debt.
The main reason Time Warner should get out of this business is that it is a slow-growth cash cow that makes it embracing the free, ad-supported content business hard. Why would anyone accelerate the cannibalization of a billion-dollar revenue stream?
Advertising, that is why. Time Warner’s clients are essentially advertisers. If you work with GM for CNN or Time magazine, it is important to be able to offer them reach online. That’s the holy grail for Time Warner, not charging someone $25/month for Web access. The person looking for Web access will look for cheaper and faster access… advertisers remain with publishers.
2 - Focus on Free, Ad-Supported Content and Media Businesses
AOL, Weblogs Inc., TMZ, Fool.com, and all of Time Warner’s online assets (Time, CNN, etc.) is where the money will be at in the years to come. I understand the focus in 2007 was ad networks, I also realize that Advertising.com (whom AOL bought for $435M in 2004) generates the lion’s share of ad revenues at AOL, but long term, holding onto and developing the content businesses will allow the most incremental upside.
3 - Spin off Platform A
I would not sell Platform A to neither MSFT, Google etc. MSFT has aQuantive. Google will ultimately own Doubleclick. There are many other independent networks and what not. But Time Warner can raise $1-5B in cash by spinning off Platform A (and keeping a portion to sell over time as it grows in value).
Ultimately, despite AOL and Netscape, Time Warner is not a technology company and I doubt TWX’s board will have the appetite and risk profile to invest what is required to compete with technology companies in the ad network space.
Conclusion:
By unloading the access and network businesses, Time Warner can raise $5-10B in cash, reduce debt and focus on pleasing advertisers.
In Could Jerry Yang be that Much of a Yahoo?, I wrote:
If Yahoo! outsources search to Google, it only adds velocity to Google’s firepower, bear in mind, Google’s growth rate is falling. Google here needs Yahoo! more than Yahoo! needs Google. What Google needs, it the financial firepower and resources of Microsoft. Oh, it also needs MSFT’s execution track record and bravado.
Why? If Google and Yahoo! remain two stocks competing for shareholders’ money, and Google wins Yahoo!’s business, Google (the stock) will far outperform Yahoo! (the stock).
From a reader:
Huh? I use to think you had some smarts, but to say that google needs yahoo more than the reverse is stupid beyond belief. are you smoking crack? Last i looked google was still increasing revenue over 50% yoy vs. yahoo. secondly google needs microsofts firepower and execution? Uhhh.. you know google has about $15 billion which is close to microsoft and when was the last time you heard anything about groove or tellme? Or what about onfolio? I understand you are long yahoo but you have lost me as a reader with this post.
Usually I would simply reply in the actual post, but this is a very important point worth diving deeper into the question at hand.
If Yahoo! outsources search to Google, it’s a no-brainer: Google wins a lot more than Yahoo!
SHORT TERM: Yahoo! wins, by a bit. Google can’t believe its luck.
Yahoo! gets a short term bump by virtue of instant improved monetization. Say at most this represents a 25% boost in search revenues. Yahoo!’s total revenues are close to $7B, so the increase would not be 25% more than $7B, but 25% more of whatever search revenue is, maybe. There is nothing that guarantees that Yahoo! will get the same monetization rate as Google does on Yahoo!’s properties. Google’s monetization is what it is because over 50% of Google’s inventory are on search pages - where the propensity to click on a paid search result is higher than on content pages.
But, there’s one more thing people seem to overlook. Yahoo! was generating 25% less revenue per click than Google before Panama’s launch. Panama has launched, it’s a work in progress, but all signs suggest that the gap between Panama and Google have narrowed. The reason why Yahoo!’s revenues in search continue to lag considerably are simply because Google has been adding market share whereas Yahoo! has been losing it. So I do not even think Yahoo!’s short term boost is really going to be 25%, I suggest it would be 5-15%.
Lastly, we look at costs. The bulk of Panama’s costs have already been invested. Yes, Panama - and any IT initiative - represents an ongoing expenditure. But who are we kidding, the bulk of the investment in time, people and money has been invested. As such, the potential cost savings are not as considerable as any one would like to suggest.
In fact, since Google would retain 5% to 50% of revenues, then it’s as if the cost savings are written off.
MID-TERM: Google Wins
Mid-term, Yahoo! would see some improvement in revenue, but it would give up all of the data that Google would be collecting. This has been alluded to by John Battelle, too. In fact, much the same way that GE became the world’s most valuable company in the post-Industrial Age era, Microsoft - and potentially Google - have become so valuable because of all of the information they have in the Digital Era. Google has the runway (data mining) and platform (Internet) to become more valuable than Microsoft, over time (initially, we said by 2010). This is why Microsoft is throwing in the kitchen sink and will stop at nothing to win over Yahoo!
Back to the mid-term prognosis: within a month or two, Google’s market share in search will continue to grow; Yahoo!’s will become moot (even if it appears on the radar, it does not own the market share points). Microsoft will probably continue to lose relevancy. AOL and Ask.com - both relying on Google - will become obsolete in the discussion, too.
So, in the midterm, Google would technically own the Internet universe’s market share and Microsoft would own less than 10%.
Google would be the 21st century version of Microsoft, who in turn was the answer to Standard Oil, the 19th century monopoly.
But more importantly, it is not Google’s market share or revenues alone that instill fear in the competition, it is its high-flying stock.
Google’s stock has fallen from an all-time high of $747 to about $495. Google remains vastly profitable, with $5B of free cash flow and nearly $20B in revenues. Google - the stock - remains a powerful currency. But given that a stock is equal to:
Net Present Value of = Today’s Income + Tomorrow’s Potential
Then Google needs to maintain high growth rates to see a growing stock price. Google admitted that its growth is slowing down.
That is for year-over-year Q4 growth rates. Yearly, the same applies:
- Google’s 2002 revenues grew 409%
- Google’s 2003 revenues grew 234%
- Google’s 2004 revenues grew 118%
- Google’s 2005 revenues grew 92%
- Google’s 2006 revenues grew 73%
- Google’s 2007 revenues grew 56%
The numbers are so big, that it needs massive add-on’s to the real estate of search it powers. Where, do you think, such growth could come from? That’s right: Yahoo!
Visually, you get:
In other words, even if Google continues to generate $20B in annual revenues it won’t be enough to maintain such a lofty stock price increase.
It is the stock price increase that allows Google to use the stock as a hiring tool (otherwise the options will be underwater) and a M&A currency (otherwise buyers will ask for cash).
So ultimately, yes, make no mistake about it: if Google takes over Yahoo!’s search, within months, and definitely within a year, Google wins by a lot more than Yahoo!
In fact, Yahoo! loses because Yahoo! would be repeating a mistake it did in 2000 when it agreed to use Google’s search engine to power the queries on its portal.
The reason why Yahoo! would lose even more is because right now, ceteris parabus, Yahoo! is better positioned in Asia - the world’s fastest growing web market - than Google.
Over time, Yahoo! can grow to become more valuable than Google (yes, I said that) based on Asia alone. But with Yahoo!’s management in place, I doubt they can take over a Chinese restaurant, let alone the Chinese market.
LONG TERM: Google Dominates
If Yahoo! sells to Microsoft and remains a separate operating unit of Microsoft, then Yahoo! + Microsoft + aQuantive has a chance, but no certainty, of one day competing with Google. Google will continue to be the undisputed number one in the market in search (Google), video (YouTube), ad serving (Doubleclick), feeds (Feedburner), etc. etc. etc.
But with Microsoft providing cover, Yahoo! has a chance to remain relevant and grow. Alone, it cannot, history has proven that. That has a lot to do with management’s missteps, such as handing off search to Google in 2000. For some analysts and Monday Morning QBs to let Jerry Yang’s disdain and distrust of Microsoft blind them to the fact that Google taking over Yahoo!’s search operations serves Google’s interest more than Yahoo!’s shows their own lack of understanding of history and bias.
The final and most important consideration is that today, Google competes with Yahoo! for shareholders’ money. If I want to be exposed to the online advertising market, I can choose between Google and Yahoo! With the opportunity to merge with Microsoft, Yahoo! has increased its value (not only because of the $31/share offer). But by remaining independent, then Yahoo! is asking to remain Google’s whipping boy. By even considering outsourcing search and repeating history, then it is showing to be suicidal.
Yahoo! is better positioned for the next wave of growth in online advertising: display/banners and video. But Yahoo! lost its way. It is vulnerable. It won’t remain independent and of all of the options (Private Equity, sale to a strategic buyer), Microsoft is the one that can be taken from concept to reality. If that makes anyone unhappy, then the lesson is: don’t go public. Yahoo! had its IPO when it had a mere 49 employees, mushrooming once to a market cap of $97B during the peak of the dot com bubble. Those days are gone. Google seems to learn from history and realizes that it might one day too lose its place at the top of the perch. Microsoft certainly understands the cycle of innovation and how upstarts can one day upstage incumbents. Yahoo!’s Board is trying to retain what’s left of its old glory. But it has run out of time.
Is Yahoo! in the arms of Microsoft ideal? No. But Google taking over Yahoo!’s search unit is even less ideal, it is borderline criminal.
Sometimes, the enemy of my enemy is my friend. Other times, the lesser of two evils is the preferred course of action.
Note: Long YHOO. Love Google. Respect MSFT. I also owned stock in aQuantive before MSFT bought that.
Assuming the Microsoft takeover of Yahoo! consummates, the investment bankers will be making a fortune:
The four advisers, Goldman Sachs , Lehman Bros., Morgan Stanley and Blackstone stand to make as much as $1.3 billion between them, analysts and experts said.
They said advisory fees range anywhere from the customary 2% of the eventual buyout price to custom-made payouts that rarely top more than 3%.
Under traditional terms, Yahoo’s bankers could split around $446 million, while Microsoft’s team might divvy up more than $890 million or 0.5% of the finished deal’s value. A review of publicly disclosed fees from 600 similar deals tracked by research firm Dealogic indicates a similar trend in comparable acquisitions.
Henry Blodget revises his alternative course of action in the MSFT/YHOO saga: basically to spin off MSFT’s web assets into Yahoo! for 50% of the company.
This is what I suggested last year (and essentially what John Battelle suggested, too).
In principle, this made sense… but once YHOO got dirt cheap (< $20/share) it became vulnerable. If you are MSFT and can now own the entire thing and YHOO has less and less leverage, why settle for less?
If anyone can convince MSFT that this is the way to go, sure, why not… but Yahoo! sat on this opportunity last year and found itself in the corner.
We shall see. One last thing: I don’t really think MSFT will care too much about short term fluctuations in its stock price if it means it will have - in the mid to long term - the web’s grand prize, Yahoo! If MSFT gets too cheap, buyers will ultimately step in and drive the price back up. Which is what happened with Yahoo! - despite doomsayers who said it would go down to the low-teens.
To see just how much leverage YHOO’s got, click here.
Note: Long YHOO.
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