Battle for Yahoo may turn hostile soon

Apr 28, 2008

The deadline that Microsoft set three weeks ago for Yahoo (yhoo) to accept its buyout offer passed this weekend without either side making a move. While some analysts expect Microsoft to launch a hostile bid, it's possible that CEO Steve Ballmer will follow through on his threat and walk away from the deal.

The three-month-old battle between Microsoft and Yahoo could come to a head fast. Yahoo has repeatedly rebuffed Microsoft and demanded a higher price - step that Ballmer has said he won't take.

Earlier news reports indicated that Yahoo's board of directors would meet on Sunday to consider their options, but there was no official confirmation of a meeting. The Wall Street Journal reported Monday that Microsoft and Yahoo did not have direct contact over the weekend. Microsoft could move as early as Tuesday, according to the Journal.

At stake is Microsoft and Yahoo's ability to compete with Google as billions of advertising dollars continue to flood the Internet. As Google has risen to become the dominant online ad player, Microsoft and Yahoo have both struggled to gain traction. Most analysts think a merger is the best way for Microsoft and Yahoo to compete with Google.

Microsoft kicked off the battle in late January when it made an unsolicited cash-and-stock bid for Yahoo that was originally valued at $31 a share, or $45 billion. The deal's value has since dropped to $29.64 as Microsoft’s shares have fallen.

While Microsoft and Yahoo executives have met to discuss the bid, Yahoo has so far spurned Microsoft. Yahoo CEO Jerry Yang has said he's not opposed to a Microsoft buyout, but argues that the offer "substantially undervalues” Yahoo. To force Microsoft (msft) to up the ante, Yahoo has discussed a variety of tieups with Time Warner, News Corp. and Google in recent months.

“Our board and management team continue to be open to any and all alternatives, including a sale to Microsoft," Yang said last week, when Yahoo reported first-quarter earnings that beat estimates.

Talks between Microsoft and Yahoo have been anything but friendly. Three weeks ago, Microsoft CEO Steve Ballmer issued the ultimatum that expired Saturday. On Thursday, when Microsoft also reported better-than-expected profits, chief financial officer Chris Liddell voiced his frustration with Yahoo's recalcitrance - and suggested the company's prepared to go to war or walk away.

"Unless we make progress with Yahoo towards an agreement by this weekend, we will reconsider our alternatives," said Liddell, suggesting that Microsoft will makes its decision know next week. "The transaction has been anything but speedy as is being characterized by what would appear to be [Yahoo's] unrealistic expectations of value."

Now that Yahoo has missed Microsoft's deadline, one of the following three scenarios is likely:

  • Microsoft turns up the heat and launches a proxy battle. The company has already hired a proxy firm and reportedly nominated candidates to an alternative board of directors. That slate would come up for a vote at Yahoo's annual shareholder meeting, sometime before the end of July. (In an attempt to stymie Microsoft, Yahoo delayed its original March 14 shareholder meeting and has not yet announced a new date. According to Yahoo's bylaws, however, the company must hold the meeting every 13 months, which means by the end of July.)
  • Microsoft walks away. The Journalreported that this seems unlikely, although abandoning the bid could increase the pressure on Yahoo to come to the negotiating table. If Microsoft drops its bid for Yahoo, the company is likely to continue acquiring online ad companies. In the past 11 months, Microsoft has spent more than $6 billion to acquire aQuantive and Rapt.

  • Status quo. Microsoft extends the proxy deadline while Yahoo tries to convince its shareholders that an alliance with Time Warner's AOL or Google is more desirable.
Microsoft CEO Steve Ballmer doesn’t want to bid against himself by upping the original deal. Photo courtesy of Microsoft.

It's not clear how much Microsoft could accomplish without Yahoo. Ballmer clearly sees Yahoo as the ammunition he needs to take on Google as online advertising spend skyrockets. According to eMarketer, advertisers worldwide spent $41 billion online in 2007 -- a figure that is expected to double through 2011 as advertisers chase after consumers who are spending more time on the Web and less time watching TV, reading newspapers or listening to the radio. Google controls 40% of the overall market while Yahoo and Microsoft's MSN have 15% and 5.2%, respectively. Google commands an even greater share in the lucrative search-ad business, with 58.7% of the market compared to 18.1% for Yahoo and 12% for MSN, according to the latest Nielsen data.

Microsoft fears that Google, with its March acquisition of DoubleClick, the world's biggest online ad server company and big player in the increasingly lucrative market for online display ads, will seize an even bigger portion of the ad market as MSN falls further behind.

Microsoft isn't the only one worried about Google. A number of media and Internet giants are now circling Yahoo -- one of the last independent large-scale online players. "Microsoft's forcing...everyone to make a move," says Frank Addante, CEO of Rubicon Project, which helps publishers manage their online ad inventory.

Time Warner (twx), which owns and CNNMoney, has pursued a deal that would fold AOL into Yahoo in exchange for a 20% stake. Along with aligning with AOL, Yahoo is also looking into outsourcing search advertising to market leader Google (goog). Last week Yahoo finished a two-week test that ran Google ads for searches on Yahoo’s homepage. The Justice Dept. is reportedly investigating the test for possible antitrust violations.

News Corp. has approached the deal from different angles. Yahoo and Rupert Murdoch’s News Corp. (nws) held preliminary talks about a possible partnership after Yahoo rejected Microsoft’s bid. When those discussions stalled, News Corp. began talking with Microsoft about a three-way alliance that would combine News Corp.’s social networking site, MySpace, MSN and Yahoo.

Many analysts argue that ultimately a Microsoft-Yahoo combination is the best option for Yahoo shareholders -- and for Microsoft in its war with Google. Wrote Bernstein Research analyst Jeffrey Lindsay in a note to investors on Friday: "We expect the acquisition scenario to play out before the end of July (the theoretical outer limit for the Yahoo! shareholder meeting) and think the outcome is very likely to be a sale to Microsoft at a slightly improved price."

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