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The Microsoft-Yahoo! Mating Dance

Understanding the ins and outs of the brewing takeover battle requires parsing what each company said—and what each didn't

Microsoft (MSFT) isn't happy with Yahoo's (YHOO) decision to spurn its $44.6 billion takeover bid, but the software maker is going to let Yahoo! live with the consequences a while before applying added pressure.

Microsoft said as much, however politely, on Feb. 11 when it called the offer, extended on Jan. 31, "full and fair." The remarks came in response to Yahoo's earlier statement that Microsoft's bid "substantially undervalues" the company. The interchange is part of a delicate dance that, while cordial now, could soon turn hostile. "The process is following a reasonably well-known mating ritual," says Joseph Grundfest, a Stanford Law School professor and former commissioner of the Securities & Exchange Commission.

To understand the process, it's important to parse each company's statement for what has been said and, just as important, what hasn't. For example, Yahoo's statements suggest there is a price that fairly values the company and ostensibly would be acceptable. Microsoft just hasn't hit that number yet.

Passing the Buck to the Board

Importantly, Yahoo says it's the company's board that believes Microsoft's bid undervalues it. The company didn't say bankers or legal advisers feel that way. It leaves open the question whether the bankers at Goldman Sachs (GS), Lehman Brothers (LEH), and Moelis & Co., which are advising Yahoo, concur. The same goes for Yahoo's attorneys at Skadden, Arps, Slate, Meagher & Flom.

What's more, nowhere in Yahoo's release does the company describe Microsoft's offer as "inadequate." That's a key word, loaded with legal meaning that in mergers-and-acquisitions-speak could torpedo the deal. Instead, the company said only that "the proposal is not in the best interests of Yahoo and our stockholders."

There's even a line in the Yahoo statement that could suggest the company is ready to sell if Microsoft ups the ante. Yahoo says the board remains "committed to pursuing initiatives that maximize value for all stockholders." That could be an invitation to increase the offer, something many analysts expect Microsoft to eventually do.

Reserving the Right to Go Hostile

There's some parsing to do with the Microsoft statement as well. In its statement, Microsoft says it's "unfortunate that Yahoo has not embraced our full and fair proposal." That suggests Microsoft isn't interested in offering more, at least not yet. Without any competitive offer or any alternative plan from Yahoo, there's little need to rush on that point.

What if Yahoo does nothing? Well, Microsoft says it "reserves the right to pursue all necessary steps." Of course, that's the threat of going hostile. That means taking matters directly to shareholders. To do so, Microsoft would most likely file an exchange offer with securities regulators that outlines its stock-and-cash bid for Yahoo. That's made more difficult by Yahoo's "poison pill" defense, which gives shareholders the ability to buy stock at a significant discount if an unwanted bidder buys 15% or more of its shares.

To get around that, Microsoft would also have to replace the majority of Yahoo's board with a group that wants the deal. That takes a proxy fight. Microsoft would have to nominate a slate of directors to be voted on at Yahoo's annual meeting. According to Yahoo bylaws, shareholders can submit matters for the meeting any time from Feb. 13 to Mar. 13. Last year's meeting was held in June.

There's still time before Microsoft needs to go that route. If Yahoo is indeed just looking for more money, Microsoft certainly has the financial wherewithal to pony up. And that too is standard operating procedure in corporate courtship. "If the telephone call doesn't work, you send flowers. Then you send candy," Stanford's Grundfest says. "And if that still doesn't work, you might suggest that you are carrying a gun. But the question then is whether you are willing to pull it out and whether it is indeed loaded."

Greene is BusinessWeek's Seattle bureau chief.

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