As nearly every company involved with the Internet reels from the implications of Microsoft's surprise May 3 withdrawal of its unsolicited $45 billion bid for Yahoo, two questions remain unanswered: Does Steve Ballmer's "no" really mean no? And if it does, what's next for Yahoo and Microsoft?
Only Microsoft Chief Executive Ballmer and Yahoo (YHOO) co-founder and CEO Jerry Yang can answer either question, and they're keeping their own counsel for now. However, a source close to the talks, which heated up only in recent weeks after more than two months of negotiations via press leaks, indicated Microsoft (MSFT) does not appear to be walking away (BusinessWeek.com, 5/3/08) simply as a negotiating tactic. Moreover, it seems clear that although Yahoo was for sale at some price, that price was high enough to indicate it much preferred to remain independent—even with the likelihood of lawsuits by shareholders angry at the deal going south. As expected, Yahoo shares tumbled on May 5 with the resumption of trading, off 19% to 23.29 on the Nasdaq.
But the grim reality is that prospects for both parties apart now look worse than ever. "Due to this exercise, both companies are weaker now," says Tyler Moebius, CEO of the online advertising network Adconion Media Group. Talent continues to stream out of both companies' ad operations. He says that a third of the 75 people he has hired in the past year came from Yahoo or Microsoft.
Longer term, a number of people in the industry think Microsoft and Yahoo still could make a mark. "Google has very little presence in the display world," notes Joe Apprendi, CEO of online ad network Collective Media. "Yahoo could have an edge in catching up to search vs. Google catching up in display." Meanwhile, Microsoft is spending hundreds of millions of dollars trying to build out its own ad capabilities. But the question remains whether Microsoft or Yahoo can avoid losing so much ground in the short term that any long-term progress will prove too little, too late.
A Win for Google
The two companies' positions look especially frail versus their common enemy, Google (GOOG). If there's one company that benefits from the failure of the blockbuster deal, it's the search giant, whose march through the advertising world remains virtually unchecked. "Its two main competitors are separate and floundering," says Clay Moran, an analyst with Stanford Group. "We think Google's the winner."
That's why many people are not entirely convinced by the posturing of Microsoft and Yahoo officials last weekend, which maintained that the deal is irretrievably kaput. They find it hard to believe that Ballmer would go to all the trouble of spending three months pursuing Yahoo for $45 billion, only to chuck the deal on a price difference of $5 billion or less when the stakes vs. Google are so high. "I have to believe they will get back to the table," says Anant Sundaram, a professor of finance at Dartmouth College's Tuck School of Business, who has followed the deal's machinations.
Even Ballmer's letter to Yahoo indicated he still believes this is a worthwhile deal—at an acceptable price that apparently can't be above the $33 a share that he offered in recent days. Moreover, Ballmer made an oblique overture to Yahoo shareholders in his letter to Yang. "I still believe even today that our offer remains the only alternative put forward that provides your stockholders full and fair value for their shares," he wrote. "By failing to reach an agreement with us, you and your stockholders have left significant value on the table."
Eye on Yahoo Shareholders
As for Yahoo, the deal was not something it wanted or perhaps even needed, at least for now. For all its troubles, Yahoo is still profitable. It still has many strong properties in finance, sports, and e-mail, not to mention a well-known brand name. And it still has the leading position in display advertising. Indeed, some industry leaders believe online display ads are poised for a spurt relative to search ads, thanks to new technologies, the rise of ad networks that are finding ways to boost their returns, and the accelerated move of large brand marketers who are looking to make an impression, not just elicit a click.
But once Microsoft made its offer, with its huge 62% premium to Yahoo's stock price, it also appeared that understandably impatient Yahoo shareholders wouldn't stand for anything that didn't net them at least as much. So several observers think that if Yahoo's stock price spirals down close to the $19 a share it stood at when Microsoft made its bid, Yahoo shareholders—who now include a significant number of arbitrageurs who likely would jump even at Microsoft's original $31-a-share offer—will clamor for Yang to get back in touch with Ballmer.
If Yahoo's stock price ultimately settles only a few dollars a share from its May 2 close of 28.67 (which was up 7% on the day), however, Yahoo's executives and board may not feel pressured to make that phone call very soon.
The upshot of the abandoned takeover is that each company may now turn to alternative deals in an attempt to improve their respective positions.
Problem is, as difficult and time-consuming as a Microsoft-Yahoo merger would be, the alternatives at this point look far less promising than what they could have offered each other. Essentially, both of them keep falling further behind Google because individually neither has a critical mass of visitors whose very search queries reveal what kinds of products and services they're looking to buy.
None of the alternatives being discussed gets either company the kind of scale in search advertising they need to compete with Google. Yahoo remains a leader in online display advertising, such as banner and video ads, and could try to build on that leadership. Among the alternative deals Yahoo has indicated it has sought are alliances with Time Warner's (TWX) AOL unit and News Corp.'s (NWS) MySpace social network.
But both of those are problematic in other ways. For one, News Corp. Chairman Rupert Murdoch appeared recently to switch sides, proposing to ally with Microsoft on a deal. Even were Microsoft to do a MySpace deal, it's unclear social network sites provide attractive advertising opportunities on a scale with search advertising. Google, which already has an ad deal with MySpace, said several months ago that it was having trouble making money from ads on social networks.
AOL, while strong in online display advertising thanks to its leading ad network Advertising.com, is seen as a traffic laggard that Time Warner has been trying to offload for some time. Yahoo already has much more traffic than AOL, so the benefits are uncertain.
Besides, Ballmer has already expressed interest in AOL, and Microsoft has so much more financial resources than Yahoo that it's unlikely the latter could win a contest for AOL. Finally, either company might face regulatory issues over such a combination, especially in areas such as e-mail and instant messaging where each has significant market share.
Yahoo's best hope remains a deal to have Google take over at least part of the advertising around its search business. Yahoo recently ran a trial of Google ads alongside Yahoo search results. Both companies indicated the trial was successful, and sources have indicated a fuller deal could come as early as next week. Again, however, regulatory concerns could quash or at least delay any such combination.
Awash in Cash
As for Microsoft, without having to buy Yahoo it now has intact an unparalleled war chest that some observers said could be applied to buy many other companies, from tech news network CNET (CNET) to ValueClick (VCLK), which is an ad network specializing in the lucrative and fast-growing field of generating leads to marketers. But none of those purchases would add up to nearly the scale Microsoft would achieve with Yahoo.
Microsoft also could try to spend some of the dollars it would have spent on Yahoo to buy the rest of hot social network Facebook, in which it bought a tiny stake last year. But Facebook has not been able to get serious traction from advertisers any more than MySpace, possibly because people using the service aren't in a mindset to be responsive to advertising. As a result, its implied $15 billion valuation is seen by many as far too high for the actual value of the company.
At the same time, both Microsoft and Yahoo are still busy trying to integrate a number of other acquisitions they made over the past year. Microsoft bought ad conglomerate aQuantive last year for $6 billion and people in the online ad industry say it still hasn't gotten its arms around all the operations. Yahoo bought ad network BlueLithium and ad exchange Right Media last year, among others, and is still in the process of integrating those. So adding more deals could create new problems and delays. "It is extremely difficult to integrate and innovate simultaneously," notes Kevin Lee, executive chairman of search marketing firm Didit.
Meanwhile, Google is poised to move quickly into online display advertising with its recently closed deal to buy display ad firm DoubleClick. As a result, neither Microsoft nor Yahoo alone may be in a position to hold off Google, let alone gain on it.