By Adam Lashinsky
May 5, 2008

I wrote Friday about the daunting math that Microsoft (MSFT) suddenly faced if it didn’t significantly boost its stake in Yahoo (YHOO). In short, though Yahoo insiders and generally supportive institutions control less than 40% of Yahoo’s outstanding shares, they easily control a majority of shares likely to be voted in a hostile proxy contest. Average Joes rarely vote in such fights, boosting the power of the pros. Why Microsoft’s bankers at Morgan Stanley didn’t figure this out sooner — or why CEO Steve Ballmer didn’t listen — is one of the intriguing tales that may yet be told.

As of the opening bell Monday morning, however, the math changes immediately. There were reports over the weekend of high fives among the Yahoo senior management group. With Yahoo shares down almost $6 to $23 in early trading, there’s a new calculus. Now the shareholders who urged Jerry Yang to reject Microsoft just watched $14 billion evaporate, the difference between Yahoo’s current price and the $33 Microsoft said it was willing to pay.

Some quick thoughts as the story develops:

* How much director’s and officer’s insurance does Yahoo have? They’re going to need a lot. Bill Lerach may be a convicted felon now, but others will take his place, and Yang & Co. just made a decision on behalf of the owners of Yahoo to walk away from a ton of money.

* The ultimate irony of all this is that Steve Ballmer’s main goal in buying Yahoo was to keep its advertising inventory out of the hands of Google (GOOG). Though a Yahoo-Google arrangement is going to require tough-to-secure regulatory approval, Microsoft’s mishandling of the bid has effectively driven Yahoo into Google’s arms. At least for now.

* This doesn’t leave Yahoo in a position of strength. Listen to how UBS analyst Ben Schachter describes the situation to his clients:

“While we believe there are 3 potential near-term catalysts for the stock (partial outsourcing of search to Google, unlocking the value of its Asia assets, potentially deeper cost-cutting in non-core businesses), Yahoo!’s execution remains the problem, as the company has not been able to execute better targeting and measurement on its own site effectively enough over the past 15 years. We are not willing to give them the benefit of the doubt that they can make meaningful improvement over the next three years, particularly given a heightened competitive dynamic where Yahoo! will now be competing against Google, Microsoft, AOL, and possibly others.”

* Where does Microsoft shop next? The party line is that there’s nothing else big enough for Microsoft to buy. Yet it has a war chest of $44 billion ready to go. Will it make Facebook an offer it can’t refuse? Could it be the solution for AOL that Time Warner (TWX) is looking for? Will Microsoft try again if Yahoo shares remain stuck in the mud?

* What will happen to Yahoo’s board? Now Yahoo has to schedule a long-delayed annual meeting. (Google’s is this Thursday, by the way.) Will angry shareholders kick out its value-destroying board?

You May Like