BUSINESS BLOGS
BUSINESS BLOGS
category: business
12 Feb 2008

After a few - well, shall we say it - boring years, Yahoo! is turning into a soap opera.  The lawsuits have started:

The Wayne County Employees’ Retirement System of Michigan, owner of about 13,600 Yahoo shares, sued Yahoo in Delaware’s Court of Chancery

And a major investor, Mutual fund house T.Rowe Price, which owns 18 million Yahoo shares, is prompting CEO Jerry Yang to cash in his chips at MSFT’s next offer (NY Post via Valleywag).

I see this settling sooner than later.  Yes, there are a lot of egos involved, but while MSFT and YHOO are lobbying investors publicly, privately I presume the bankers and lawyers are brokering a cease-fire in the $50B market cap (or $35/share).  I can see why the most senior leadership on both sides want to be seen as looking out for shareholders.

The major power broker will very well be Capital Research and Management who owns 6% of one and 11% of the other.  Here’s why I think they all want a happy merger sooner than later: to remove the uncertainty and to make way for the creation of a $400B market cap behemoth.

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.

Read more in the original post here.

Note: Long YHOO