BUSINESS BLOGS
BUSINESS BLOGS
category: business
09 Feb 2008

Before 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.