BUSINESS BLOGS
BUSINESS BLOGS
category: business
09 Feb 2008

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  He could have withdrawn his offer, seen the value of Dow Jones’ stock fall back to the pre-deal levels, and then bought it cheaper, causing a lot of conflict internally at the Dow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