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Why Yahoo's Yang Is Holding Out

Though beset by restive shareholders and pressure from Carl Icahn, Yang has his reasons to push for a better deal from Microsoft

For more than a month, Yahoo (YHOO) co-founder and Chief Executive Jerry Yang has endured a withering attack by shareholders who say he let a $47.5 billion acquisition bid by Microsoft slip through his fingers. The apparent obstinacy, which Microsoft (MSFT) says fueled its decision to walk away on May 3, was laid bare in a shareholder lawsuit. The documents, unsealed June 2, allege Yang and Yahoo's board created deal-killing measures, including an expensive employee severance package.

On June 3, corporate raider Carl Icahn joined the pile-on. Icahn, who's trying to win seats on Yahoo's board in hopes of reigniting a Microsoft-Yahoo merger, echoed the lawsuit's charges that "Yang's deep hostility toward Microsoft" and his "defensive and self-interested conduct" scuttled the deal. Icahn also told The Wall Street Journal that if his proxy campaign is successful, he'll try to oust Yang, whose company's stock has plummeted from 33.63 a share on Oct. 26 to 26.15 on June 3, a drop of more than 22%.

Protective Stance

The big question in the minds of shareholders—from institutions such as Capital Research Global Investors and Legg Mason Capital Management to Icahn and the many hedge fund investors hoping to make a quick buck on a Microsoft deal—comes down to this: Why has Yang remained so recalcitrant in holding out for a better deal?

It turns out Yang has a number of reasonable justifications for resisting Microsoft's unwanted advances. And according to analysts, sources close to Yahoo, and people who know Yang, the reasons behind his surprisingly spirited negotiating stance go well beyond those often cited in news reports and lawsuits, such as Yang's emotional attachment to his company, his deep-seated hatred of Microsoft, or a desperate desire to cultivate a legacy as an Internet visionary.

The overriding reason for the board's four-month-long-and-counting holdout against Microsoft's offers is simple, according to people familiar with Yahoo's thinking, who insist neither Yang nor the board is inalterably opposed to a deal: The company wants more money. But what that means is more complicated than merely asking Microsoft to bump up its offer by a couple dollars a share.

For one, say these people, Yahoo seeks some hedge against regulatory hurdles that could delay or even quash the deal. Such issues could take a year or more to work out, analysts say. Indeed, Google (GOOG)'s much smaller $3.2 billion acquisition of ad firm DoubleClick announced in 2007 took nearly a year to get a nod from regulators. And if regulators quash the deal, Yahoo could be left crippled.

Search Operations Only?

Moreover, Yahoo is looking for some certainty that the value of the deal will hold, people say. Given that Microsoft's original bid was half-cash and half-stock, the transaction's value is subject to movements in Microsoft's stock. As Microsoft's share price dropped amid concern over the challenges of integrating so large a target, so did the value of the deal—by several billion dollars.

There's also no guarantee that Microsoft's stock won't fall after the deal closes. After all, analysts note, it took a 12-year campaign to gain a leadership position online, and Microsoft has little to show for its effort beyond an Internet division that continues to lose money—$775 million on sales of $2.4 billion in the last nine months. It wouldn't be beyond the pale for Yang to be reticent about getting swallowed by a company that has performed even more poorly online than Yahoo, which remains profitable despite its other shortcomings. Microsoft's share of search queries, for instance, is 10%, compared with Yahoo's 18%, according to Nielsen Online.

All the reasons for the board to resist a Microsoft takeover notwithstanding, Yahoo investors clearly have little confidence that an independent Yahoo can turn itself around. Yang has been unable to pull off that feat in nearly a year since taking over as CEO. So people close to the situation believe a deal of some kind still remains likely.

Yahoo and Google are discussing an arrangement whereby Google would handle search and related advertising for Yahoo. But after weeks of speculation that it's imminent, nothing has been announced. Microsoft is also discussing a deal that may involve a purchase of Yahoo's search operations only. Those talks appear to be more active. That arrangement may even prove attractive to shareholders, especially hedge fund investors who had been hoping for an acquisition, the quickest way to cash out of what was intended to be a short-term investment.

Google's Unchecked Success

Sandeep Aggarwal, an analyst with financial-services firm Collins Stewart (CLST.L), estimates that if Microsoft paid $15 billion for Yahoo's search operation and $3 billion a year to run ads on Yahoo Web pages, such a deal could add up to $9 a share to Yahoo's stock price—well north of Microsoft's last offer of $33 a share. "Maybe there's more value Yahoo can extract with just a search deal," Aggarwal says.

The big uncertainty after all this time is whether the two sides can find middle ground. One person familiar with Yahoo's thinking says the board, no doubt softened up by Icahn's entry into the fray, is more amenable to a Microsoft deal than it was a month ago. What's more, some people who know Yang and Yahoo's board think the reported resistance to a Microsoft deal is overblown. "There are people in the Valley who have cultural issues with Microsoft," says Ellen Siminoff, an early Yahoo executive who's now chairman of search marketing firm Efficient Frontier. "I don't think Jerry is one of those people. He doesn't have an irrational view or hatred of Microsoft."

Whatever reservations he may have, Yang no longer has the luxury to indulge them, because he faces more than just a voracious Microsoft and angry shareholders. Yahoo and Microsoft face a more formidable rival. "Google's running free, they own the frontier," says Stephen Mader, vice-chairman and managing director of board services for Korn/Ferry International (KFY). "Microsoft and Yahoo both suffer from Google's success." As long as they've held out so far, Yang and his board may not have much more time to decide what to do next.

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