From the time MSFT launched an unsolicited takeover bid for Yahoo! and earlier this week, we covered every angle of the story possible, to the point that one of our readers asked, WTF?
We decided to tone it down a bit, but it’s been a few days since we talked about the deal at all, so it’s high time we dust off the dossier and look at what’s happening. The storyline is mezmerizing, a real soap opera.
1. Yahoo! Board: Divide and Conquer
Roy Bostock serves on the boards of directors of Morgan Stanley (who is representing MSFT, by the way), Northwest Airlines and Yahoo! He was the Chairman of Yahoo! for all of one day when MSFT launched a somewhat-hostile bid, helping up the price of Yahoo! stock from $18 to $29. If that does not spell out “effective Chairman” I am not sure what does.
On a more serious note, by virtue of not being your typical wine-growing, hippie-loving Silicon Valley type, Bostock understands that a Board’s obligation is to represent shareholders and a Chairman in particular serves as the liaison between management and investors.
It is the Board’s fiduciary duty to do what is best for shareholders, and as such, it’s not surprising to see Bostock lining up on the side arguing to accept MSFT’s bid, albeit he will probably try to up the bid to the best of his abilities. Bear in mind, Morgan Stanley represents Microsoft in this matter. Does that matter? You better believe it, he’ll be able to relay the message that a higher bid will grease the wheels enough to make accepting MSFT’s offer a fait accompli. More importantly, Morgan Stanley - along with Lehman Bros., Goldman Sachs, Blackstone and Moelis & Company - stands to make major fees if the deal goes through. If Morgan Stanley were repping Yahoo!, I’d still make this case (after all, bankers are not volunteers), but the fact that Morgan Stanley is repping MSFT and Mr. Bostock sits on the board of both Morgan Stanley and YHOO should not be taken lightly, especially after all banks have been hit heavily with losses in their sub-prime business. For the record, in no way am I suggesting impropriety or anything, but if anyone knows about the importance of heavy hitters on one’s board to pull strings, it should be Valley citizens. As a result, Bostock is torn and faces conflicts of interest, but to quote Silicon Valley dean and Kleiner Perkins VC John Doerr, “no conflict, no interest”.
For YHOO CEO Jerry Yang, an architect of the Web’s first iconic brand, the lesson is simple: if you want to run a company emotionally then:
a) don’t take your baby public
b) choose your allies (ie. board members) carefully
c) set up dual-class shares and keep voting control, as the Google guys did.
2) Cutting the Fat at Yahoo!
Some time ago (before MSFT’s bid) I asked if Jerry Yang was secretly trying to reduce some of the fat off Yahoo! to position it for a sale. Clearly, seeing his aversion and allergic reaction to MSFT’s bid, I now doubt that is the case. But I will say that Microsoft is welcoming seeing both layoffs and resignations at Yahoo! It will make integrating Yahoo! much simpler, from a management, accounting and strategic perspective.
In fact, I think the market is speaking loud and clear: they are welcoming layoffs and resignations at Yahoo! in what can only be described as a vote of no-confidence at Yahoo! and a suggestion that Microsoft management can do a better job managing Yahoo!’s assets. Given MSFT’s torrid growth at its core operations, it’s not an incorrect conclusion, frankly.
3) You Always Have Other Options?
Let’s see. Last week, the AOL/Yahoo! merger came up. We shot it down as nonsense. Earlier this week, the News Corp. hookup rumor crept up again. More nonsense. Why would Rupert Murdoch do that? He’s getting $900M in guaranteed revenue from Google… why would he totally give up control of Fox Interactive Media (which he built with $2B) for a chunk of Yahoo! that he cannot really control day-in, day-out, nor consolidate its financials, for that matter… so not surprisingly, the desperate Yahoo! camp is now once again touting the AOL merger talk, which we are convinced won’t happen.
4) Behind the Scenes
I expect members of Yahoo!’s Board to start having discussions with MSFT’s bankers and lawyers, if they’ve not already started doing so.
You might have noticed that when Yahoo! first rejected MSFT’s offer, the press release mentioned that the Board members had their own external counsel. Usually companies have Directors and Officers insurance that covers them against many things including shareholder lawsuits. For them to publicly mention that they have their own counsel suggests far more dissent than you would think. My gut says that a few of the Board members are considering resigning and the fact that they went public - albeit somewhat anonymously - with accusations of Yang’s emotional reaction to the offer was a warning to Yang et al.
As well, you might have noticed that missing in all of this is President Sue Decker. I am not sure quite what to make of the following, but Microsoft has just hired Decker’s former colleague, Blackstone’s Jill Greenthal. As I mentioned last week, the behind-the-scenes of the MSFT/YHOO showdown will create a far more interesting tale than what you see in black and white in press releases and what not.
We were one of the first ones to outline the cross-ownership between the two companies, but unlike most, our conclusion is that these shareholders want a quick resolution to what is not starting to look like the inevitable. As a result, if you connect the dots you start to see this deal coming to a “friendly” agreement at $50B.
5) When the Silicon Valley Dream Died
The bigger storyline here, I think, is the following. Reading Michael Arrington’s observations on Seattle vs. Silicon Valley, he stated: “If you want to change the world and are willing to do absolutely anything to achieve your dreams, there is no better place to be than [Silicon Valley].” He is probaly right… but when MSFT ends up gobbling YHOO, a lot of the facade and innocence (if you can call it that) about the Valley will go down the drain.
This is by no means a knock at the Valley. But the premise of starting a company and taking it public evaporated in March 2000 when the Nasdaq got decimated. But for many in the Valley who dislike and distrust MSFT, seeing all-around nice guy Jerry Yang have to lose control of his purple baby to Redmond will probably make a lot of, or least some, realize that going for the jugular isn’t all it’s hyped to be if it means seeing it go the way of Yahoo!
Note: Long YHOO.
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.
Assuming the Microsoft takeover of Yahoo! consummates, the investment bankers will be making a fortune:
The four advisers, Goldman Sachs , Lehman Bros., Morgan Stanley and Blackstone stand to make as much as $1.3 billion between them, analysts and experts said.
They said advisory fees range anywhere from the customary 2% of the eventual buyout price to custom-made payouts that rarely top more than 3%.
Under traditional terms, Yahoo’s bankers could split around $446 million, while Microsoft’s team might divvy up more than $890 million or 0.5% of the finished deal’s value. A review of publicly disclosed fees from 600 similar deals tracked by research firm Dealogic indicates a similar trend in comparable acquisitions.
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