It’s been one week since Microsoft launched an unsolicited $44.6B acquisition bid for Yahoo!
It’s been one week and Yahoo!’s options are running out. It looks like the deal is a fait accompli. Trying to outsource search to Google will only strengthen Google and launch a plethora of shareholder lawsuits.
When Kara Swisher wrote “it’s not quite over” I thought, maybe it’s not. But then reading the post, you see that indeed, it is almost over.
Then when I came across Alley Insider and saw: “we’re curious to hear whether the speakerphone in the Yahoo boardroom produced any ideas that eluded TechCrunch, SAI, Boomtown, the New York Times, and a dozen other outlets earlier this week,” I could not help but think: are you challenging us Blodget?
So here goes:
Is Yahoo! bound to become a unit of Microsoft? Well, not necessarily. Here is a crazy strategy for Yahoo! to remain independent. The challenge, basically, is offering something to shareholders who have lost patience and faith in the leadership of Jerry Yang and Sue Decker.
Decker, it should be noted, is on the board of directors of Berkshire Hathaway, Warren Buffett’s holding company. Also on the board is Microsoft chairman Bill Gates. Yes, that will make the next board of directors’ meeting interesting. Gates has been a major beneficiary of Mr. Buffett’s generosity and philanthropy. This does not guarantee anything, but if Decker can actually prove her worth by getting Warren Buffet on board (figuratively, and maybe literally), then Yahoo! has a chance of survival.
We’re not talking about getting MSFT to pitty Yahoo! to leave it alone. We’re actually about to suggest a counter-proposal that we believe Yahoo! can make to shareholders without hammering its stock price and causing a massive revolt amongst shareholders.
But, it will come at a cost.
Step 1: Sue Decker Gets Warren Buffett to Invest in Yahoo!
Berkshire Hathaway has never invested in any technology stock. However, Yahoo! being a new media company that is - even with MSFT’s 62% premium offer - offering a margin of safety, Mr. Buffett might consider the company because of its strong brand, cash flow and debt-free balance sheet. Buffett looks for a few things before investing, these are:
- understanding the business: Yahoo! is not fundamentally different than Capital Cities, a media business.
- getting a margin of safety
- being debt-free
At a market cap of $40B, Berkshire Hathaway’s $10B investment in Yahoo! nets Buffett a 25% stake in the company and a board. Buffett won’t become the Chairman of the Board however, he will appoint someone to it.
While Yahoo!’s enterprise value remains the same, its market cap now rises to $50B (current market cap plus the $10B in cash); its cash holdings rise from $2B to $12B, remains virtually debt free with a paltry $750M on its books.
Step 2: Warren Buffett picks up the phone and engages Bill Gates to invest, and not buy Yahoo!
MSFT understands that if history repeats itself, it will succumb to Google because every pioneering innovation and business model becomes vastly more profitable than its predecessor [related: will GOOG be worth more than MSFT by 2010?].
However, both Gates and Buffett recognize that mergers and acquisitions pose considerable risks, and hopefully will realize that messing up the Yahoo! deal is a bigger risk than not completing it.
Bill Gates and Microsoft invest $10B and merge MSN.com/Live.com (valued at $10B) into Yahoo! This $20B injection puts their stake in Yahoo! at 28.5% [related: should MSFT spin off MSN/Live into Yahoo!?]
We’re not as expensive as Lehman Bros., Goldman Sachs of Moelis & Company, but to see how we get those numbers, it’s simply:
a) $6.5B in cash + $10B in assets = $16.5B,
b) $16.5B + Yahoo! initial $50B = $66.5B.
c) $16.5B / $66.5B = 24.81%
So right now, Berkshire Hathaway owns 25% (they did not dilute when MSFT came on) and MSFT has 24%. Yahoo! retains 51%.
Yes, the ownership is fragmented. And yes, Warren Buffett will usually side with his close friend Bill Gates, giving them 49% of the vote. To convince MSFT to go along, this comes at a cost.
To get Microsoft to back off pushing the envelope with the bid, Bill Gates (or Steve Ballmer) becomes Chairman of the Board of Yahoo!
For this proposal to be reasonable, this has to be fair to both sides. We respect Jerry Yang wants to remain independent and protect his company, employees and users, but in exchange we feel that Mr. Yang would be willing to make this concession. To those who will decry and say this is blasphemy, the alternative, right now, is Yahoo! becomes an operating unit of Microsoft and Yang is forced to leave, along with Decker, co-founder David Filo).
When the dust settles, Microsoft owns 24.81%, Berkshire Hathaway owns 25%, Yahoo! retains 50.19% but Bill Gates becomes Chairman of the Board.
Bear in mind, ultimately, who cares what we say. We think the big idea here is compelling. MSFT would gladly (I think) give up the Chairman role and invest more to have over 50% of the company. I think Yang et al. are more reluctant to give up control than the Chairmanship. Of course, it is true that MSFT, and not YHOO, holds a few more chips going into the discussion, and this is why getting the Oracle of Omaha on side initially is key.
Regardless, and most importantly, Yahoo! now has a much bigger warchest: Berkshire Hathaway has invested $10B, Microsoft $6.5B, which along with Yahoo!’s existing cash hoard of about $2B means that Yahoo! has over $18.5B to compete with Google.
This is a key component. Facebook realized that Google, and not MSFT, was the main challenger of all things Web [related: Facebook vs. Google clash over email, the mother of all social networks]. The sooner Yahoo! realizes this, the stronger it can become. Google only stands to win if Yahoo! outsources search to Google.
Step 3: Maintain status-quo in Asia
Now a fork in the road. We believe that Yahoo! should retain ownership of its Asian holding, namely Alibaba and Yahoo! Japan. We talked about this some more here.
As shareholder ourselves, one of the few reason we are even willing to consider not accepting Microsoft’s offer are those Asian holdings, where some peg the online ad market at an eye-popping $110B.
Were Yahoo! to sell or spin off the Asian holdings, the company might come into a $10B windfall, but these would be taxable gains, which makes it all less interesting. Another option is to sell these for cash or equity to Softbank, but once again, it would be strategic for Yahoo! to maintain these holdings.
There is an option to look into Morris Trust regulations that might allow a tax-free spinoffs, but there would be a lot of scrutiny.
Step 4: Raise $2.25B in Debt
Warren Buffett dislikes debt, but he inderstands the value of leverage better than anyone else. Even Berkshire Hathaway, for example, has $34B of debt on its books.
We suggest Yahoo! raise $2.25B in debt. You will see why.
Once this is done, Yahoo! will have $3B in debt on its book, and $18.5B in cash, meaning it will have $21.5B to invest, if it wanted to.
Step 5: Yahoo! Acquires AOL from Time Warner
When Time Warner sold 5% of AOL to Google for $1B, it essentially put a floor on AOL’s price. Today Time Warner has $37B in debt. That’s a lot of debt to finance. Its cash hoard is less than $2B. We are confident that Google is in fact not interested in acquiring AOL, because it does not invest in content. We think that Time Warner should in fact keep AOL and spin off its network business (more here), but the company has enough on its plate that it just might unload all of AOL for $20B in cash, which after the $2.25B debt financing would be something Yahoo! could afford. Under the $20B deal, Yahoo! would be left with $1.5B in cash, which is essentially what it has now.
Step 6: Yahoo! Bundles All of Its Ad Network Business and Spins Them Off in an IPO
The last step is the most progressive one and an extension of something we have argued: Yahoo! should take Right Media, Blue Lithium, the newspaper consortium and spin it off. Now that MSFT has sought to acquire Yahoo!, priorities have changed. But under our scenario, Yahoo! would be buying AOL in Step 5 and inheriting AOL’s network business, dubbed Platform A, which consists of Advertising.com, Third Screen Media, Quigo and Tacoda. We are confident that it makes more sense for any company to spin its network business away because it unleashes value without taking away any of the benefits it provides the parent company.
Combining all of these assets and benchmarking them to numerous comparables, Yahoo! would be able to create a company valued at $5-10B, and assuming it sells off 50% to the public, then it can raise $2.5B to $5B of cash. It can then use some of these proceeds to pay off the $3B of debt it had after Step 5.
Within one year, Yahoo! would have well over $2-5B in free cash flow from these business, if not more.
To conclude:
When the dust settles, this is a lot of back channel diplomacy and financial engineering, but it is not out of the realm of possibility. Would most shareholders go for this when they have one bird in the bush in the form of a $31/share offer from MSFT?
I don’t know. Heck, I don’t if even I could pull this off. In fact, even if I could, I’m not even sure if I would take this “road less traveled” over a $31/share (though I think the deal will ultimately be for $50B., but that’s a separate post).
Maybe that is something the expensive investment bankers can answer in their reports and analysis.
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WatchMojo NewsletterSame time frame: December 2007.
Same sourse: comScore.
Same market: the US.
The inevitable has happened.
In December 2007, in the US, there were more video streams than search queries.
There was 10.03B search queries:
Compared to 10.1B video streams:
This is huge folks. It also explains my call that in 1 decade, online video advertising will surpass search engine advertising.
Alley Insider pointed out that Capital Research Management owns 6% of Yahoo! and 11% of MSFT. CRM met with MSFT yesterday to assess what the impacts of this deal will have on its holdings in the companies. Obviously, with YHOO surging and MSFT falling in the past week, in the short-term, given CRM’s bigger holding in MSFT and MSFT’s larger market cap, CRM has had a rough time.
In fact, the figures are 5.95% and 11.36% respectively. So what has happened to their holdings in the past week?
In one week, they have lost $2.16B. It should be noted that buyers always see a pounding to their stock price initially… but over time, this would be a winner for CRM I think. Let’s assume the final price is indeed $44.6B, what happens to CRM’s stakes?
Rightfully or wrongfully, we’ll assume that the YHOO value climbs to $44.6B and MSFT falls by the same amount. You now see the loss narrowing:
Over time, I suspect that MSFT will get back - if not to the $330B levels - but at least to $300B within a quarter, the company’s core businesses are growing ferociously… as you can see, quickly, CRM would be in the black.
In the next year, I expect MSFT to get back to its pre-deal level of $330B. Now you see CRM making a $2B profit from the proceeds of its stake in YHOO:
Within 1 year, tops, the combination of MSFT/YHOO would create a powerful option for investors looking to invest in something less pricey than Google. Suppose the combined entity would grow to $400B in value, then CRM’s stake would look like:
Of course, by now some are wondering what I am smoking… but it’s not crazy to suspect that MSFT + YHOO would command much better growth prospects. In fact, by adding YHOO’s $7B revenue streams onto MSFT’s $51B 2007 revenue base, combined with YHOO’s higher P/S multiples pushing MSFT’s P/S and P/E up… MSFT being a $400B company is not out of the realm of possibility.
MSFT’s P/S is 4.52, YHOO’s is 5.81. Combined, the new company would have something near 5.25. Google’s is 9.50.
MSFT’s revenue grew from $44B in 2006 to $51B in 2007.
For 2008:
- without YHOO, just last week Microsoft raised its full-year forecasts for fiscal 2008. Revenue is now projected to be $59.9 billion to $60.5 billion, up from the Oct. 25 forecast of $58.8 billion to $59.7 billion, an increase of 1.3 percent on the high end. The average of $59.9 billion to $60.5 billion is $60.2B.
- Yahoo! alone will do $7.2B to $8B, according to their recent earnings call.
Combined this means a revenue range of $67.1B to $68.5B, or an average of $67.8B.
Using a 5.25 P/S multiple, this projects MSFT’s value to be $355.5B.
That’s just using the P/S and revenues. There’s a lot of cost savings (MSFT pegs this at $1B) and the P/E projection - while less obvious - is more interesting. MSFT netted $14B in 2007. Yahoo! only $600M. Combined you are looking at a company that nets $15B in profits. Google generated $17B in revenues!
More importantly, MSFT would be able to invest all more into IT to make Yahoo! competitive. MSFT’s current P/E is 16 (but this after the week-long slide after the YHOO deal was announced), YHOO’s is 60. YHOO’s is indeed distorted due to its holdings in Alibaba and Yahoo! Japan, but there is no way that investors won’t give a combined entity firing off all cylinders in software, entertainment and online advertising anything less than 30. Google’s P/E as a pure play online advertising/search play is 38 P/E.
MSFT/YHOO profits of $15B x a P/E of 30 is $450B.
Even if the P/E is a more sedate 25, then at $15B profits, you are looking at a company worth $375B.
At half of Google’s P/E, you get a multiple of 18, that yields $270B. But, that is way too low cause MSFT is right now at 16 and was above this before the YHOO was announced.
For this reason, a post-merger YHOO/MSFT would be worth near $400B (average of P/E and P/S basis) and more than offset any decline MSFT has faced this week.
To conclude, we think that Alley Insider is being foolish by maintaining a very short term horizon to assess CRM’s thoughts on this deal. CRM is probably urging MSFT to up the bid a bi, maybe even to $50B so that YHOO and MSFT amicably forge a partnership to usher in, or restart, the 21st century. In that case, we suspect the payoff table to look like this:
And based on our figures, in one year:
I like rumors and crazy speculation as much as the next guy, this one is dead on arrival:
Shares of media company CNET Networks Inc, currently battling dissident shareholders who want to expand its board, soared more than 7 percent on Friday, on speculation that Google Inc might be interested in acquiring a stake in it.
Options volume also soared on the speculation.
“There is a rumor circulating that Google might have an interest in CNET. Therefore, the options volume has picked up dramatically on that rumor,” said William Lefkowitz, options strategist at brokerage firm vFinance Investments in New York.
I doubt it. Google won’t be buying content anytime soon. Won’t happen with NYT, or CNET. Read more on why in this interview with Google VP of Content Partnerships David Eun:
The head of Google’s content partnerships insists that the Internet behemoth won’t be a competitor to traditional media. Producing content is “not our business,” he says. “Journalists, news bureaus — that’s not what we do.”
Read the interview or learn more on CNET/GOOG here and here.
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