BUSINESS BLOGS
BUSINESS BLOGS
category: business
09 Feb 2008

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.