On Monday, Yahoo!’s board will thank Microsoft’s board for their interest and pass on the $31/share offer. Yahoo!’s position, in short, is that the MSFT offer is “vastly undervaluing the company”. Via the media, it has signaled to the world, including MSFT, that it would consider any bid over $40/share and it has adopted a poison pill that would make a proxy fight messy, protracted and expensive. Most importantly, it will be lengthy and the outcome will be uncertain.
Some argue that MSFT’s next move will emulate Rupert Murdoch’s reaction to the Bancroft family’s initial reaction to Mr. Murdoch’s unsolicited $5B offer: “thanks, but we’re not interested”. In that case, no one else was to match the offer. The fear was similarly a disdain for Murdoch’s track record with letting Church and State meddle too much and muzzle editorial independence. While the Bancroft’s protracted refusal would have led to a shareholder lawsuit, the Dow Jones voting structure gave shareholders only posed a legal risk for the Bancrofts, and not an actual control risk (if they wanted to remain independent, they could have).
Where things differ considerably, we think, is the hunger and drive of the buying party. In Dow Jones, Rupert Murdoch saw one of the strongest brands in journalism, the strongest brand in finance, the most successful paid subscription website in an otherwise undervalued online asset. However, Mr. Murdoch was in no rush to buy Dow Jones. He could have withdrawn his offer, seen the value of Dow Jones’ stock fall back to the pre-deal levels, and then bought it cheaper, causing a lot of conflict internally at the Dow Jones company and Bancroft family. He stuck to his gun and ultimately paid $5.7B for the company. Today, Dow Jones is a unit of News Corp. and dare we say it, it’s found a home and a parent who will take Dow Jones’ venerable brands to the next level.
With Yahoo! and Microsoft, it is fundamentally different in that if Microsoft were to refuse paying more, we would find ourselves in a temporary stalemate. The overhang on MSFT stock would persist, and this is what we think Capital Research and Management (who owns 11% of MSFT) wants to avoid. It also owns 6% of Yahoo! Any investor in MSFT understands that what has gotten the stock to rise from $20 to $35 or so is the income generated from MSFT’s cash cows: Office and Windows. But for MSFT to ever get back to its once-lofty highs and to continue its ascent, it needs to be exposed to online advertising: a rapidly growing market and one that Google is leveraging its strength in to take the offensive to MSFT.
We’ve covered all of this aplenty. The point is: while Mr. Murdoch is older than Steve Ballmer of Bill Gates, ironically he was more patient than MSFT will ever be. MSFT can smell YHOO’s blood, it knows that the additional cost to winning YHOO’s approval is $5-10B whereas the full cost of losing Yahoo! would be far greater.
To put things into context:
- MSFT currently has $20B of cash on hands,
- MSFT has $0 debt,
- MSFT generates $12-15B in free cash flow per year,
- MSFT once paid out a $36B dividend, and
- MSFT will generate $60B in revenue in 2008, it could raise $20B in debt and pay the federal funds rate if it demanded it…)
Most importantly, run the math and you will see that a combined MSFT/YHOO entity would command, overnight, a $400B market cap if you approximate the joined company’s price-to-earnings and price-to-sales multiples over the new company’s revenue and income projections.
MSFT is now at $265B down from $330B, if it is down, it’s not because of the dilution it will incur over buying YHOO, it is because of the uncertainty in whether it will buy YHOO, how long it will take and what will happen if it does not buy YHOO.
YHOO says if wants a buyout price of $56B, maybe they will get it. Maybe they won’t. But unlike Murdoch, I think that Ballmer and Gates are thinking that this fight might be easier and less messy than they expected, and if all it takes is to sweeten the offer to $50B, then I would be surprised to see them hesitate.
In fact, when you consider that MSFT paid $6B for aQuantive (it was trading for $1-3B in the months leading up to that deal) you have to wonder if Yahoo! is not worth much more to them. For this reason, MSFT might want to pre-empt Yahoo!’s back and forth by simply checkmating Jerry Yang et al. with a $40/share offer, which works out to the desired $56B.
Of course, Gates and Ballmer like a good fight, too… so we think they will first counter with a $50B offer, or $35.91… but they will do so after announcing that they have accumulated a 5 or 10% stake in Yahoo!… with intentions of continuing to buy in the open-market.
Then again, maybe that’s just how I would be playing this match if I were MSFT.
Disclaimer: long YHOO
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WatchMojo NewsletterBefore people accuse me of being crazy, let me state that yes:
- I have lost faith in YHOO’s management
- I believe MSFT’s 62% premium is generous
- I do not think - short of our hail marry proposal - that Yahoo! has any real white knight options
- outsourcing search to Google is criminal and I will personally sue YHOO’s management and Board for breach of fiduciary duty
- ultimately, Yahoo! will be part of Microsoft, as a subsidiary, no less.
However, I understand why the Board had to reject this deal. Allow me to explain.
I tried to investigate Moelis & Company’s background to find out why they were brought in to assist Yahoo!’s bankers Lehman Bros. and Goldman Sachs, who along with Microsoft’s bankers Morgan Stanley and Blackstone stand to make $1B in fees. The only connection is that Moelis COO Elizabeth Crain worked at Morgan Stanley at one time. Of course, in the past, Goldman represented MSFT in some deals. Are they maybe working the phones to find out how much more MSFT would pay. We also know that Capital Research and Management - who owns 6% of YHOO and 11% of MSFT - stands to lose in the short-term but will win big time in the long term as MSFT gets a better grip of the booming online ad market via a deal with YHOO.
Regardless of how the bankers are earning their fees, I think much of the Board meeting discussions revolved around the question of risk management: how to avoid any lawsuits from irritated shareholders, on either side of the argument: the sell or pass camps.
Tech Crunch’s Michael Arrington (shockingly late to comment, let alone report on this news) adds:
Perhaps this ordeal finally jolted Yang out of whatever alternate reality dreamland he was dwelling in. Perhaps the board saw some fire in Yang’s eyes at the meeting yesterday that made them willing to put their personal fortunes on the line and give a collective middle finger to Microsoft (because, yep, they’re going to be sued, and fast, by their stockholders if this deal dies - and the board’s indemnity agreements won’t provide full protection).
Unlike hitherto-asleep-at-the-wheel executives, most of Yahoo!’s shareholders want to sell at $31/share, but given that YHOO was trading at $34 in November 2007 and $40 in January 2006, I can understand and respect that some shareholders would have some hesitation about selling their shares to MSFT, especially when you consider:
- YHOO is beating Google is Asia, the world’s fastest online ad market.
- YHOO is positioned to outgrow Google in display/banners and video, two areas that are faster growing than search, Google’s bread and butter.
- YHOO is actually well positioned but its problem is that as a benchmark to Google, it is an ugly step-sister that no one really expects will out-grow Google. For that reason, its stock will forever trade at a discount to GOOG’s (when adjusted for the fact that YHOO is a holding company, too, with investments in Alibaba and Y! Japan).
Even MySpace Intermix, chased by Attorney General Howard Spitzer and languishing at $5/share, was sued by major shareholder Brad Greenspan for accepting News Corp.’s seemingly generous $11/share offer. The point is: you never know. The Board can say no, MSFT can counter with “$31/share is the highest we’ll go” and the Board could always re-evaluate it. But as many have noted, the prevailing wisdom is that MSFT would go higher. I suspect there has been some back channel dialog going on to gauge where the settlement price will, well, settle.
All to say, as a board member, you have a fiduciary duty to shareholders to maximize the share price. In other words, is there a danger that MSFT backs off? Yes, but it’s slim. If MSFT were to pull its bid, YHOO would fall to $20. But shareholders would be so fumed that if anyone came out with a $25/share offer, they would be forced to take it. MSFT understands this so it won’t do that. They’re close, they can smell blood, they know if they up the bid even remotely the pressure will be too great for YHOO to refuse the second offer.
Negotiations 101 is as follows:
- MSFT offers $X
- YHOO counters with $Y where Y > X
- depending on leverage etc., final price settles in between X and Y.
I’d like this to settle at $50B, up from $44.6B, YHOO has asked for roughly $56B. I don’t think MSFT needs to go that high, but they very well might, because this deal would make MSFT as strong in online advertising and search as it is in operating systems, productivity suites, and home entertainment. That would make MSFT sleep better as it takes on everyone including Apple and Google, two companies that right now have a legitimate shot at overtaking MSFT in market cap. A YHOO deal, while expensive, would keep those companies at bay and create what we project to be a $400B market cap company.
So ultimately, the Board saying “we’ll pass at $31/share” is risky, and they might very well face lawsuits if this falls apart, but in all likelihood, this was what the brain trust at Moelis, Lehman and Goldman assessed would be the best reaction to avoid any lawsuits from any camp within the YHOO shareholder base.
Disclaimer: Long YHOO.
There is some confusion over what price it would take to close the YHOO/MSFT deal.
This has a lot to do with understanding the difference between shares outstanding and float. Yahoo!, for example, has 1.25B shares in its float but 1.39B shares outstanding.
The float is the number of shares the company has issued, the shares outstanding are what are freely-traded. To simplify the matter, this implies Yahoo! has about 124M shares that are restricted and not trading on the open market. I’d have to read every single share agreement to know if those would in fact be at play in a deal, because sometimes stock vests when there is a liquidity event, such as a sale of the company. For this reason, it’s important to note that it is more cautious to use the 1.39B number, because ceteris parabus, shares are vested and tradable when there’s a liquidity event. For this reason, it is “more right” to assume that to get a $50B market cap deal, MSFT would have to offer $35.91… this is why this deal is very much alive… Yahoo! is asking for $40/share but I think a $36/share offer would get the deal done. As a shareholder, obviously I prefer $40/share, but no need to be greedy.
Yesterday’s board meeting at Yahoo! seems to have concluded with Yahoo! decided to reject MSFT’s $31/share offer as it was deemed to drastically undervalue the company.
In all fairness, considering that Yahoo! was trading at $34/share in November 2007 and $40/share in January 2006, this should come as not surprise.
Also not surprisingly, we hope anyway, Yahoo! was only considering the outsource search to Google strategy as a whisper strategy because that would a) reinforce Google, b) weaken Yahoo! as a company and as a stock and c) unleash a massive negative shareholder reaction.
Fearing that MSFT might take the hostile route (so far, while the bid was unsolicited, it was not hostile), Yahoo! has adopted a poison pill.
As onlookers and shareholders, we actually think this reaction is the smartest one, for one, it shows that Yahoo! is willing to play nice, won’t be pushed over in selling for as low as $31/share, and would consider an offer that better reflected the company’s assets.
The WSJ reports (more in this CNET article) that Yahoo! will relay its position formally to Microsoft’s board on Monday. We doubt Yahoo! would explicitly say so, but rumors circulate that Yahoo! is seeking - and would consider - a $40/share offer.
Yahoo!’s float is 1.25B but it has 1.39B shares outstanding, this is what is causing different reports on what it takes to get a deal done,
- a $40/share offer x 1.39B shares implies a $56B deal,
- a $40/share offer x 1.25B shares projects a value of $50B.
To compare apples with apples, I think it will take a $50B deal. So:
- using the number of shares outstanding (1.39B), this is a $35.91 offer,
- using the float, that is $40/share.
This is why different sources are confusing the matter. To see the difference between shares outstanding and float, click here.
Incidentally, last week we argued that the “ultimate final` MSFT’s offer and accepted bid will come in at $50B”, see the post here.
While Yahoo!’s options remain limited, we believe that MSFT would gladly consider paying $5.4B more than it was initially willing to pay if it means avoiding the hostile route and showing goodwill.
It will be very interesting to see how the stock market would react. In some ways, it’s anyone’s guess. But we suspect YHOO will shoot past $31/share and nudge ever-so-closely to whatever price implies a $50B market cap…
Why do I think this will settle at $50B?
MSFT’s stock will actually stabilize because the market will be able to put a floor on how much the acquisition would cost MSFT, and as a result… if both sides play nice and remain diplomatic, you will see a slow upward progression in the weeks to come towards $40. Bear in mind, at the time of this post, we remain long YHOO.
Remember, even News Corp. ended paying $5.7B (14% more than its initial, supposedly too-good-to-pass $5B offer) for Dow Jones. Taking this bid from $44.6B to $50B is 12% more. While MSFT’s stock has fallen to $28 or so and its offer was for $31 in cash and shares, let’s be realistic: MSFT would have had to keep its price at $31 for Yahoo! to consider that… so if Yahoo! hints at $40/share, and MSFT agrees, a 12% increase is not unacceptable. We also argue that a combined entity would be a $400B company once the dust settles, so MSFT shareholders would welcome the deal if it can be done with as minimal uncertainty and is as little bit of time.
Most important in this process is time, and not money. MSFT has ample financial firepower to make a $5-10B additional payment. If it can walk away with Yahoo! at $50B then both Steve Ballmer and Jerry Yang can emerge victorious.
Alley Insider published a fantastic must read this morning, a 857-word ditty on Microsoft’s colossal mistake, which I (usually the verbose one when it comes to ‘blog’ entries) can sum up in 2 words: Google envy.
The mid-form version, simply, is that businesses are happy to pay for software, and will do so for web-based software too (ie. Saleforce.com). Essentially, MSFT’s thinking that ad-supported free software in the clouds is the silver bullet it needs is pure folly, or a colossal mistake.
Google envy has killed many companies, it is driving some very erratic investment behavior by VCs (most of whom lack a lot of experience in media and any in advertising, what drove Google to a $200B market cap).
I think SAI is right in arguing that businesses don’t need, or want, free ad-supported software. But that’s half the problem and I do not think that Blodget recognizes what is fully driving MSFT’s decision. Maybe that’s the difference in perspective of an analyst as opposed to that of an executive.
Entering the ad business was not initially about survival for Microsoft (or fear), it was about greed. Don’t get me wrong, greed is part of the business DNA of all entreprises, and the epicenter of it all is in Silicon Valley (Google and Yahoo!’s backyard) and not Redmond. As such, greed is what drives Google’s decisions today, and for a lack of better terms, “greed is good”.
But with regards to MSFT, only in the past year with Google’s Apps strategy has fear become part of the driving force.
Once Google bought Writely and launched web-based alternatives for Excel and Powerpoint did MSFT fear becoming irrelevant. But that is not, we think, what has-been driving MSFT to invest so much into its online advertising business .
Similarly, today, with MSFT breathing down its neck is suddenly Yahoo! fearing anything: initially, it was greed that drove Yahoo! to emulate Google by acquiring Inktomi and Overture.
The problem then, with both Yahoo! and MSFT has not been the cause of the action but the result - or lack thereof - or the consequence:
- Yahoo! is a disgrace from an execution perspective, and some of this might be as a result of the fact that no one challenges Chief Yahoo! Jerry Yang.
- MSFT’s failure to generate any profits or gain traction in online advertising and search stem from its lack of web DNA and understanding of the medium, pure and simple.
In other words, Google managed to exploit Bill Gates’ slowness in “getting the Web” (if you doubt me, ask yourself why Gates’ “The Road Ahead” has nary a mention of the web) and Yahoo!’s sheer apathy in the face of search.
In “If Yahoo! outsources search to Google, who wins?” I outlined Google’s tremendous revenue growth (along with its’ recent slowdown). Indeed, since 2002 Google has generated upwards of $35B in revenues, which with margins of 25% represent nearly $10B in profits. If that does not lead to Google envy, I don’t know what does.
Of course, with those profits, and driven by greed - the heartbeat of capitalism - then Google can reinvest to take on:
- Yahoo! in display advertising as a starting point for consumers (as it has been doing more and more) and in video advertising (as a source of entertainment).
- Microsoft in software and services.
Judging Google on its track record, it has fully positioned itself to surpass Yahoo! and financially has done so in aggregate terms (its share of online advertising is staggering because search accounts for 40% of all ads online, but its intake of display/video is puny, something that is important as video and display outgrow search ads in years to come).
But with regards to MSFT, it has yet to really assemble the product assortment or infrastructure required to put a dent, let alone kill MSFT. For this reason, to bring things full circle, we are not yet convinced that MSFT’s foray in online advertising or search is a colossal mistake. We think it’s simply a different strategy, one of taking it to Google by arguing that the best defense is a resounding offense.
MSFT seems to recognize that a “go-at-it-alone” strategy to take on Google (or YHOO) in online advertising or search has failed to live up to MSFT’s ambitions and objectives, so it’s pulling out all the stops and making an effort to take on Yahoo!
Whether it is driven by fear or greed, we think that risks notwithstanding, this is something that Microsoft should fully pursue and had Yahoo! shows as much ambition then it would not have suffered the inevitable fate it’s about to face.
- Only the Paranoid Survive vs. Innovator’s Dilemma
- YHOO/MSFT more about online ads than cloud computing
- Will Google surpass MSFT in market cap by 2010
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