Yahoo Hits Back at Icahn

In a May 15 letter to Carl Icahn, Chairman Roy Bostock details negotiations with Microsoft and defends the board's actions

Just hours after billionaire financier Carl Icahn launched a battle to replace Yahoo's board and get the Internet icon back into talks with onetime suitor Microsoft (MSFT), Yahoo! (YHOO) fired back. In a May 15 letter to Icahn, Yahoo Chairman Roy Bostock disputed Icahn's characterization of Yahoo's aborted talks with Microsoft as "completely botched" and insisted Yahoo's current board is the best group to lead the company.

Bostock's letter provides some of the most detailed insight yet into months-long negotiations between Yahoo and Microsoft, which on Feb. 1 made public its unsolicited takeover offer of $31 a share. The strongly worded riposte also underscores the company's resolve to chart its own course in the face of investor criticism over how it has grappled with competition from Google (GOOG) and responded to Microsoft's overtures.

At the same time, the letter gives little indication of Yahoo's next move in response to Icahn's broadside. The only hint comes in Bostock's statement that "we have been and remain willing to consider any proposal from any party including Microsoft if it offers our stockholders full and certain value." The latter adjective, "certain," indicates Yahoo considered a key obstacle to reaching a deal to be Microsoft's half-stock offer, whose value declined along with Microsoft's market value since the initial bid.

Bostock also shot back at Icahn, whose earlier withering letter said Yahoo's board "acted irrationally." Icahn nominated 10 potential directors, including himself, lieutenant Keith Meister, Dallas Mavericks owner Mark Cuban, and former Viacom (VIA) Chief Executive Frank Biondi Jr., expressing hope they'll be more willing to cut a deal with Microsoft. Bostock noted that no offer is now on the table from Microsoft or anyone else. "We do not believe it is in the best interests of Yahoo! stockholders to allow you and your hand-picked nominees to take control of Yahoo! for the express purpose of trying to force a sale of Yahoo! to a formerly interested buyer who has publicly stated that they have moved on," he wrote.

"Misunderstanding of the Facts"

The letter outlined in some detail how the three-month-long talks proceeded with Microsoft. It disputed Microsoft's contention when it walked away from the deal on May 3 that Yahoo's board didn't bargain in good faith. "Unfortunately, your letter reflects a significant misunderstanding of the facts about the Microsoft proposal and the diligence with which our board evaluated and responded to that proposal," Bostock wrote.

Bostock said Yahoo's board met more than 20 times to review Microsoft's proposal and other alternatives. He also said senior management of Microsoft, Yahoo, and their financial advisers spoke on "numerous occasions" and met in person seven times. Bostock said that Yahoo at an Apr. 15 meeting presented a list of "key non-price deal terms," to which he said Microsoft did not respond. He also repeated Yahoo's contention that Microsoft did not deliver its final $33-a-share offer in writing and did not include details of the mix of stock and cash, which could affect the actual value of the offer.

Although Bostock's letter didn't make Yahoo's course of action clear, Yahoo's options today appear limited. A potential deal to let Google run its more lucrative ads alongside Yahoo search results hasn't come to pass, despite a trial that both companies said was successful. Likewise, nothing has come of rumored talks about combining forces with Time Warner's (TWX) AOL or News Corp.'s (NWS) MySpace.

And analysts say none of those deals is likely to hike Yahoo's value to near Microsoft's last offer. Yahoo shares rose 61¢, or 2.3%, to 27.75 on May 15.

Support System

What's more, many shareholders don't appear supportive of Yahoo's board. New York hedge fund Paulson & Co. has bought 50 million Yahoo shares and indicated it will support Icahn's slate of directors. Even longtime Yahoo holder Bill Miller of Legg Mason Capital Management cut the fund's Yahoo stake by 22%, to 72.2 million shares, though Legg remains the second-largest shareholder behind Capital Group. "Everyone seems to be climbing on the Icahn bandwagon," says Barry Genkin, a senior partner at Philadelphia law firm Blank & Rome. "He can put so much muscle on this," says Genkin, also chairman of the firm's shareholder activist practice.

Other shareholders are expressing support for Icahn, too, in hopes that he can push Microsoft and Yahoo back into each other's arms. "There's a really good shot that Microsoft could come back at the right price and if the Yahoo board is supportive of the deal," says Ryan Jacob, portfolio manager of Jacob Internet Fund. "Microsoft and Yahoo's shareholders understand that the combination gives them a decent chance to compete with Google."

Adding to Yahoo's challenges, the company this time faces a raider who, even more than Microsoft, will take no prisoners. In Microsoft, Yahoo had a suitor that, if unwelcome, at least had an interest in making sure the most valuable of Yahoo's assets were retained and enhanced over time, once inside Microsoft. Icahn has no such interest, so if Yahoo continues to resist and manages to prevent a deal with Microsoft, Icahn may force changes that could reduce Yahoo's long-term prospects.

Back to the Drawing Board?

If Icahn can't get Microsoft back to the table, for instance, he might insist Yahoo sell off valuable stakes in fast-growing properties such as China's Alibaba. Or he might lobby for a deal to outsource all of Yahoo's search advertising to Google, analysts have speculated. Yahoo and Google have been talking about a more limited deal, but an arrangement that ends Yahoo's search efforts completely would also limit its potential for growth. Those prospects, analysts and shareholders say, could help drive Yang and his board back to Microsoft.

At the same time, Microsoft's strategic imperative for the deal hasn't changed, in many analysts' view. The company needs Yahoo's huge audience of more than 500 million unique visitors worldwide to compete with Google in online advertising. And even though Yahoo's share of the search-advertising market is far smaller than Google's, it's still way ahead of Microsoft's. "Microsoft really does not have a Plan B, especially to win in search marketing," says Sandeep Aggarwal, an analyst with Collins Stewart.

New negotiations may not happen immediately, however. Genkin notes it's in Ballmer's interest to sit on the sidelines for now, letting Icahn do the dirty work to try to soften up Yahoo's resolve. For its part, Yahoo likely will take some time to assess how much shareholder support it has to hold out for a higher price, if not independence. "But unless somebody at Yahoo pulls a rabbit out of his hat, this kind of thing can't go on in perpetuity," Genkin says. At the least, the drama could come to a close at Yahoo's July 3 shareholder meeting when all the votes will finally be tallied.

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