Microsoft Yahoo Acquisition Update

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Let’s say that you run a nice company, a well-known company that has done well by most accounts, having grown from just an idea to one of the best brands in its field. You took this company public before the dot com crash, and saw your stock rise from mere dollars to almost 115, until a broader economic downturn pushed you back down to almost where you started. Lucky for you, the core of your business has sound fundamentals, and the same trend that pushed your stock up initially helped reignite some value in your share price. Over the next three years, it went from mere dollars to resting comfortably in the mid-thirty to mid-forty dollar range. That was until your rival, whom you had the opportunity to buy, came from obscurity to redefine the public perception of your strengths and weaknesses. That which you had the lead, you now fall further behind, your share now just half of the new market leader. More botched potential acquisitions follow, thrown in with some management turnover, and after some heavy spending by the corporate development team, you re-emerge (not that you went away per say) as a company with a focus on becoming dominant in an area not yet controlled by your once-rival. In this grand story, you find yourself not alone in being vanquished by the start-up you could have bought. A fellow competitor in the field, so used to domination, finds themselves in the uncomfortable position of third place despite a talent pool better than the Western Conference of the NBA, and more money than many nations. This latter company, the Ahab to the dominant player’s Moby Dick, who now is just a Dick, after spending billions themselves trying to catch-up, makes a bold move of their own, an unexpected offer for your company. What do you do?

This drama which began on February 1st when Microsoft first made the offer for Yahoo – a $31 per share, half cash, half stock deal that reflected a more than 50% premium over where Yahoo was trading – Yahoo has since done everything in its power to show no interest in taking the deal. It looked for anyone else who might want to buy them, coming close, it seemed, to a deal that would have made much more sense, but ultimately finding itself alone and facing an outwardly patient Microsoft. Rarely, in our lives, will we witness what we have so far and what we will as the story among Yahoo, Microsoft, and Google unfolds. Put yourself as the head of Yahoo, the founder who came back to lead the company he created, having experienced its highs, lows, highs, and potential lows again. Ever since Google surpassed you and went public, you’ve seen your stock not just grow slowly but not grow at all. Despite its easy to bash nature, though, incredible turnover, and black hole of employee morale, the end users have made it still one of the largest single properties online and one that makes billions annually. In 2005, the company grossed 5.2 billion, which grew to 6.4 billion in 2006, but only increased modestly in 2007 to 6.9 billion, the latter growth falling well below the Internet advertising sector as a whole. As a mature company, even with overall sector growth still strong, that doesn’t mean that they can grow with the market. Google, a much younger company has long outpaced the growth of the market, but they too have shown signs of slowing down. Yahoo, unlike Google, doesn’t have any magic levers it can pull to increase or decrease revenue. So, what would you do in this situation?

If you are Yahoo, even though you couldn’t find another suitor, you formally reject the offer. Is it a surprise? No. How many people take the first offer they get? If somebody wants you, they will probably offer you a little more, even if they say the offer they’ve given takes everything into consideration. We’re entering the final leg of this drama, though, with Yahoo knowing that Microsoft could try a hostile takeover if they so chose, so they have resorted to focusing solely on making themselves seem much more valuable than the initial offer by Microsoft. I don’t envy them. Yahoo wants an offer closer to $40, but how do you convince someone to pay that when your stock hasn’t seen anything close to that level in more than two years? Yahoo’s stock last topped forty for a very brief period in the end of 2005 and the beginning of 2006. How do you do it? You do what any startup would when trying to show a higher value, even in the fast of iffy past performances, you paint a wonderful hockey stick scenario for your revenue and profit growth. In Yahoo’s case this means that you won’t just grow 10% like last year, but 25% for the next two years. It certainly begs the question, "If you could have done that, why didn’t you already?" Are the acquisitions of Right Media and Blue Lithium really going to lift yields that much higher? They don’t have the same upswing in the favor that AOL did when it acquired Advertising.com, and while the promise for growth definitely exists, I do realize that it seems impressive to the say the least. Visit the founder of Blue Lithium’s blog before you make up your own mind.

In the end, here’s what we predict. Microsoft will end up paying $34.50 for Yahoo, and they will try to do so before Yahoo announces their first quarter earnings. Yahoo has gone all in, and Microsoft will want to call and try to end this before the river card turns. Taking a step back from the details of the purchase, what we’re seeing is not search versus display but a battle for the advertising operating system. And, the reason Microsoft would pay more than they should follows the same line of reasoning why Google overbid for DoubleClick – defense as a form of offense. They can; they will; they feel they need to. In the meantime, they’ll spend tens of millions if not more on advisers and lawyers, instead of getting down to the work of competing, and Google will continue to leverage the time to spread blatant misinformation in an attempt to derail the acquisition. Google tries to point out that this deal would be bad for advertisers and users, that it, in the words of Google CEO Schmidt, would "break the Internet and diminish choice." What it really means is that since they wouldn’t be allowed to buy Yahoo, Microsoft shouldn’t either. Advertisers are already stuck between a rock and a hard place, and to avoid either the rock or the hard place (depending on which you view Google) from becoming Alcatraz, we actually need a deal like this to happen. With the launch of their self-serve product, Google is already one mega step closer to securing a leadership role in display, and if it means trading one emperor for another, we might have too. At least Microsoft makes a good game system.

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