Google's Yahoo Rebound Play
After more than four months of Sturm und Drang, the blockbuster Internet deal of the year is over, with only one clear winner: Google. On June 12, Microsoft and Yahoo said they ended talks that focused on, at turns, an outright takeover by the software giant to a combination of the companies' Web-search operations. Within hours, Google swooped in with a long-discussed alternative deal that involves placing search ads on Yahoo pages.
Despite hints before the market closed that a Google (GOOG) deal might finally come to pass, the sudden end of chances for a more sweeping Microsoft (MSFT) transaction left Yahoo (YHOO) investors fleeing for the exits. The company's stock fell 10%, to 23.52. That's still considerably above the 19.18 where Yahoo's shares sat just before Microsoft made its original $45 billion bid on Feb. 1, but far below the $33 a share Microsoft offered before bowing out.
Ichan Unlikely to Prevail
Yahoo valued its deal with Google at as much as $800 million in annual sales. Under the nonexclusive arrangement, Google will run search-related text ads on Yahoo in the U.S. and Canada. The deal caps Google's dominance of search advertising, the most lucrative market on the Internet. The company's 62% share of online search queries, and an even higher share of search-ad revenues, continues to grow. "It's a great deal for Google," says Shar VanBoskirk, an analyst with Forrester Research (FORR).
The announced end of the Microsoft deal also leaves Carl Icahn, the financier who launched a proxy fight (BusinessWeek.com, 5/15/08) in hopes of forcing Yahoo back into a deal with Microsoft, with few apparent alternatives. Icahn, who bought his Yahoo stock at an average of about $25 a share, now could lose money if he can't come up with another plan and decides to sell. "He took the horses to the water but he couldn't make them drink," says Barry Genkin, who chairs the shareholder activist practice at law firm Blank Rome.
Genkin says it's now unlikely shareholders will vote for Icahn's proposed new slate of Yahoo directors ahead of Yahoo's Aug. 1 annual meeting unless he can articulate another plan to improve Yahoo's stock price. Absent that possibility, Genkin favored a Google deal. But investors so far don't seem impressed with it.
Yahoo's shares initially rose 1% in post-close trading after the Google deal was announced. But later they continued falling, perhaps in part because Yahoo said the Google deal won't result in material cost savings. Yahoo will continue to operate its own search engine and search-ad system, called Panama, on most search queries in the U.S. and Canada and on all queries elsewhere in the world. The upshot: Opportunities for cutting staff and technology spending are few.
Under the deal, Yahoo can run Google text ads alongside Yahoo search results, as well as on other Yahoo pages on its U.S. and Canadian Web sites. Yahoo controls when and where Google ads will run, and executives said during a conference call that Google ads would appear only on a portion of Yahoo search results. The long struggling Internet company called the deal an "$800 million revenue opportunity," though neither Yahoo nor Google would reveal whether there are any revenue guarantees.
Yahoo also estimates that within the first year of implementation, it will generate $250 million to $450 million in additional operating cash flow. "This puts Yahoo on a faster track to creating shareholder value," Yahoo co-founder and Chief Executive Jerry Yang said on a June 12 conference call. Yahoo President Sue Decker said the additional revenue should help Yahoo spend more on its other opportunities, such as its leadership position in display ads, the marketing messages that appear in fixed blocks on Web pages.
No Regulator Approval Needed?
However, analysts and others remain skeptical of the deal's long-term benefit for Yahoo. "I have no idea what Yahoo's thinking," says Forrester's VanBoskirk. She says the deal clearly is an attempt to appease investors demanding a higher stock price, but calls it a clear admission by Yahoo that it can no longer compete in the lucrative search advertising market. Trip Chowdhry, an analyst with Global Equities Research, is even less impressed, saying Yahoo hasn't proved it can generate $800 million in additional revenues.
Google had opposed a Microsoft-Yahoo deal, saying the transaction would thwart competition, but until June 12, it wasn't clear that the search giant would consummate an alternative with Yahoo. Immediately after the outlines of a proposal were revealed in April, lawmakers said they'd look at whether it might be anticompetitive, raising the likelihood that regulators could delay or quash a Google-Yahoo plan. Senator Herb Kohl (D-Wis.), who chairs an antitrust committee, repeated his vow to look into the deal, though it's unclear antitrust law will apply to what's essentially a commercial arrangement.
But during an appearance in San Francisco on June 11, Google CEO Eric Schmidt repeated his contention that "an independent Yahoo is better for innovation and competition." Google and Yahoo argue that their plan doesn't require regulatory approval and say they've been in contact with regulators to craft an acceptable arrangement. Schmidt says it will benefit consumers with more relevant ads, advertisers with more prospective customers, and publishers with higher ad revenue.
But it's likely that Microsoft and others will press for a stringent review anyway. The companies will hold off on implementing the deal to give the Justice Dept. three and a half months to review it.
Microsoft Didn't Want It All
Consumer activists immediately weighed in against the deal. "Competition in the online ad sector—already weakened by a series of takeovers and acquisitions—is seriously threatened," said Jeff Chester, executive director of the Center for Digital Democracy. "The government must take swift action to prevent the creation of a digital combine that merges assets and services of the first and second leading online search advertising companies—Google and Yahoo."
Advertisers may be leery, too. "This is somewhat disconcerting for advertisers" who want more competition in the market, says Bryan Wiener, CEO of digital marketing agency 360i. He thinks Yahoo could suffer in the long term as advertisers abandon Yahoo search ads to go directly to Google.
Although allying with Google could limit Yahoo's future growth potential, the company may not have had much choice after spending months trying to avoid Microsoft's embrace, or at least extract a higher buyout price. Hopes for reviving a full Microsoft-Yahoo merger finally foundered on June 8, when Yahoo Chairman Roy Bostock and other board members met with Microsoft. According to Yahoo, Microsoft's representatives said the company was not interested in acquiring all of Yahoo even at the price range it had proffered. The most recent offer was $33 a share, according to Microsoft.
Microsoft said in a statement that it remains open to a more limited deal, such as an acquisition of Yahoo's search business. But a person close to the matter says Yahoo's board spurned a Microsoft offer for those operations because the board believed Yahoo needed to keep the capability in house. Microsoft was not interested in a more limited deal, this person said.
Another person who asked not to be identified said Microsoft was unwilling to make another offer for all of Yahoo, at least not at the $33-a-share price that Yahoo's board members felt was the least they could accept. By the end of April, this person said, Microsoft became less enamored of a merger because it became apparent the deal would have to be reviewed twice—once by the current administration's regulators and then again next year under a possible Democratic administration, which may be less accepting of large mergers.
Execs on the Way Out
Schmidt said the Yahoo deal came together after months of on-and-off discussions, including between him and Yahoo's Yang. The agreement culminated after an all-night session wrapping up the deal. Schmidt also said Google would like to do more business with Yahoo over time.
Investors may pressure Yahoo further if they don't think the Google plan will improve Yahoo's prospects enough to justify a higher stock price. It's unclear what leverage they will have besides selling more shares. Meanwhile, not all of Yang's Yahoos are sticking around to see what happens next.
Two senior executives, at least, are on the way out, according to various news reports: Jeff Weiner, executive vice-president of Yahoo's network division, which includes much of Yahoo's major operations, including key homepages and search; and Usama Fayyad, chief data officer and executive vice-president of research and strategic data solutions. A prominent Yahoo software developer, Jeremy Zawodny, said on June 12 that he, too, is leaving to join a company he didn't identify. They follow a steady stream of departures over the past year or more.
If Yahoo's prospects don't improve and the stock continues to fall, Yang and his board may find themselves once again under pressure to take further steps—even if it's unclear what those steps might be.