The billionaire investor has lured Microsoft back to the table, but lack of an alternative Yahoo strategy could result in a lower price
Yahoo! investors hoping for a Microsoft (MSFT) buyout finally got cause for celebration. After losing one-third of its value since a February peak, Yahoo (YHOO) shares rallied on July 7 on news that Microsoft would return to the negotiating table, provided that Yahoo's board gets ousted (BusinessWeek.com, 7/7/08). "We will be prepared to enter into discussions immediately after Yahoo's shareholder meeting if a new board is elected," Microsoft said in a statement. The stock leaped 12%, to $23.91.
But how rich a deal do investors hope they'll get? Even if billionaire corporate raider Carl Icahn succeeds in his efforts to replace the board and boot Yahoo Chief Executive Jerry Yang, he's not likely to succeed in wresting the $33 a share Microsoft once offered. Indeed, the final sale price could be much lower—in the vicinity of $27, the current value of the half stock-half cash offer made public Feb. 1.
No Top-Dollar Offer Likely
There are several reasons Microsoft may not need, or want, to pay anywhere close to the $47.5 billion it was once willing to pay for Yahoo. Time, as Microsoft CEO Steve Ballmer has often said, is money. In the five months since Microsoft announced its $31-a-share offer, economic prospects have worsened and the regulatory climate has become less favorable.
Moreover, Icahn's desire to get a deal done, and his failure to offer a strategic plan for Yahoo should a deal come unraveled, could give Microsoft a negotiating advantage. "There is no tension in the process," says a source close to Yahoo. "You would just have to trust that Microsoft is somehow interested in what's best for Yahoo's shareholders." Icahn favors an acquisition with Microsoft over running Yahoo independently and he's repeatedly maligned Yang for not closing earlier talks with Microsoft. "Jerry Yang and the current board of Yahoo will not be able to 'botch up' a negotiation with Microsoft again, simply because they will not have the opportunity," Icahn wrote in an open letter to shareholders, reiterating his intention to sell Yahoo, or at least its search business, to Microsoft.
Sources insist that Microsoft and Icahn have not discussed a sale price, but Icahn clearly gives credence to Microsoft's concerns over spending as much for Yahoo as it once offered. Icahn takes the first couple of paragraphs of his letter outlining the risk Microsoft would be taking in doing a deal with Yahoo that could keep it from offering top dollar. "[Ballmer's] logic is simple," Icahn writes, explaining that Microsoft fears losing money while the transaction undergoes regulatory scrutiny due to mismanagement. "Microsoft would be putting its money at risk and a great deal could be lost."
Shareholders Not Favoring Independence
Icahn's desire to close a deal with Microsoft without proffering alternative strategies is a key reason Yahoo's board is urging investors to vote against the financier's proposed slate. Icahn's leadership "would not lead to an outcome that would be in the best interests of Yahoo," the board said in a statement. The company also challenged Icahn to have a plan for Yahoo's turnaround, should Microsoft decide that it does not want to pursue a deal. Without one, what's to stop Ballmer from continuing to walk away until Yahoo caves? Microsoft quit talks May 3 amid disagreements over price and since then has insisted it's no longer interested in an outright acquisition of Yahoo.
The prospect of a high price is diminished all the more by an economic slump. A consumer credit crunch in the U.S., coupled with falling housing prices, skyrocketing oil prices, and fear of a full-blown recession has taken its toll on the stock market, including the tech sector. Some believe that Yahoo has been hit particularly hard by advertising budget cutbacks, particularly among financial companies. That could mean Yahoo will report weaker than expected revenues, or at least an outlook less rosy than the one it issued in March (BusinessWeek.com, 3/18/08), when it announces second-quarter results July 17.
In a July 7 note to investors, UBS (UBS) analyst Ben Schachter wrote that he believes a deal is still likely, though at a lower price than before. Whereas Schachter once believed a deal could have been done at as much as $34 per share, he now writes that Microsoft is unlikely to go higher than $33. "With the pullback in Yahoo's shares after Microsoft initially walked away, and continued weakness in Yahoo's search and display businesses, we believe that an acquisition of the whole company is now likely in the $31-$33 range," wrote Schachter, along with Heather Bellini, who covers Microsoft for UBS.
Even those numbers may prove optimistic. Investors have shown little confidence in Yahoo's strategy for remaining independent. A recent search advertising partnership with Google (BusinessWeek.com, 7/3/08) and rumors of Yahoo's talks with Time Warner's (TWX) AOL have failed to stop Yahoo's share price from falling. The lack of enthusiasm among investors for an alternative to Microsoft gives Ballmer the power to argue that his offer really is in Yahoo's shareholders' best interests.
What's Plan B?
The regulatory climate has gotten foggier since the beginning of the year, too. Microsoft initially speculated that winning regulatory approval would take a half-year. Had it clinched an agreement by early May, Microsoft might have cleared regulatory hurdles (BusinessWeek.com, 7/3/08). Now the process is likely to last into a new administration—one that may not be as friendly toward megamergers. Meanwhile, Chinese authorities have grown closer to enacting a law, scheduled for Aug. 1, that would give antitrust authorities greater ability to scrutinize large mergers. When it called off the deal, Microsoft cited regulatory concerns as a reason.
Of course, Icahn didn't become a billionaire by selling investments on the cheap. Yahoo's deal with Google, which Yahoo executives estimate could generate sales of as much as $450 million a year, offers Icahn something of a hedge. Also, Microsoft may not want to risk losing even more senior executives by offering an insultingly low bid for the company or its search business.
But Microsoft has demonstrated a penchant for changing its mind on Yahoo. As ever, it will have the option of walking away. In that event, Icahn and his board may want to have Plan B in place. That would give shareholders even greater cause for celebration.