Wednesday, February 06, 2008

BusinessWeek: Yahoo: Time for Bold Moves?

To repel Microsoft's takeover bid, the Internet giant's options include outsourcing to Google, finding another buyer, or private equity

February 6, 2008, 12:51PM EST

by Robert Hof

Let's face it: In all likelihood, Microsoft (MSFT) will end up acquiring Yahoo! (YHOO) for a few billion dollars north of the $44.6 billion the software giant offered in an unsolicited bid on Feb. 1.
But it's not a done deal yet. And Yahoo co-founder and Chief Executive Jerry Yang made it very clear in a memo to employees that he's serious about looking at alternatives. "Microsoft's proposal is one of many options that we're evaluating," he wrote shortly after the bid was announced.

Those options clearly won't be as palatable to shareholders as Microsoft's bird in the hand. Some might even provoke lawsuits. But Yahoo's reticence has raised the tantalizing possibility that it might make one of several bold moves to stay independent—or at least extract a little more money from its suitor:

• Outsource search advertising to Google.

Among several admittedly unlikely options, this one has the most credibility. As Google (GOOG) keeps commanding a larger share of the search market, now at 56% or more, rumors have circulated for years that distant No. 2 Yahoo might consider throwing in the towel. Citigroup (C) analyst Mark Mahaney reckons Yahoo could boost its cash flow this year by 25%, or $252 million, if it let Google pay it to handle search results and accompanying ads on Yahoo. Yang has recently considered outsourcing at least Yahoo's European search business to Google, according to published reports. Such a deal might well make Yahoo radioactive to Microsoft. Since the software firm's stated goal in pursuing Yahoo is to keep Google from dominating even more of the Internet, it won't want to be locked into a Yahoo deal that would benefit the search giant.

Yet this would be a bitter concession for Yahoo, which has spent several years building a system for placing ads next to search results called Panama that it launched only a year ago. Ultimately, it also could end up hurting Yahoo's advertising overall, because advertisers ideally want to be able to place search and "banner," or online display ads, using the same system. Although such a move is certainly a long shot, Mahaney adds, "We believe the possibility of this outcome is likely greater than the financial markets believe."

• Find a private equity partner to fund going private.

Yahoo has undeniably valuable assets, from its Internet-leading audience of more than 500 million unique visitors a month worldwide to significant stakes in overseas Internet companies such as Yahoo! Japan, China's Alibaba, and Korea's Gmarket (GMKT). Indeed, analysts think those properties combined are worth at least $10 billion of Yahoo's current $40 billion market capitalization. Combine a sale of those assets with even deeper cuts in personnel and capital spending and outsourcing search to Google, and Stifel Nicolaus (SF) analyst George I. Askew thinks Yahoo could earn $2.6 billion in earnings before interest, taxes, depreciation, and amortization in 2008. That's nearly $700 million higher than in 2007—a potential boost that just may be enough to justify a leveraged buyout of Yahoo.

The biggest knock on this notion, says Askew in a Feb. 4 report analyzing this scenario: "The numbers just don't work." Interest expense on $25 billion in new debt would be $2 billion a year, leaving only $600 million a year in profits. That's well short of the margin private equity firms demand to risk that big an investment. What's more, Askew adds, "Microsoft would likely top any competing bid with its own deep pockets and synergies."

• Seek out a white knight.

The same key reason Microsoft wants Yahoo, its massive online audience, could make it attractive to a wide array of media, cable, and telecommunications companies. Among the various names widely discussed as potential bidders are News Corp. (NWS), Time Warner (TWX), Comcast (CMCSA), AT&T (T), and NBC owner General Electric (GE). Some people speculate that (AMZN) or eBay (EBAY) could propose a merger.

Problem is, none of them appears eager to take on Microsoft. "We are definitely not going to make a bid for Yahoo," News Corp. Chairman Rupert Murdoch declared during a Feb. 4 earnings call. Other names thrown out seem even less likely because they have entirely different business models or challenges of their own. "Given Yahoo's size, it's unlikely an aggressive competing bid will come in," says Clayton Moran, an analyst with Houston investment bank Stanford Group Co.
• Swallow a poison pill.

In early 2001, Yahoo instituted a poison pill. It allows existing shareholders to buy new stock at a bargain price if someone buys 15% or more of Yahoo's shares. That can raise the price of a takeover to prohibitive levels. Yahoo also could try similar tactics, such as raising money to fund a big dividend. The resulting debt could cool Microsoft's ardor—but also would surely result in shareholder lawsuits, because Yahoo's stock likely would fall.

The bottom line, says Eric Jackson, a Florida management consultant who led a shareholder movement last year to force out then-CEO Terry S. Semel: "Microsoft has really backed Yahoo into a corner." Before long, Yang's options for spurning this particular suitor may well run out.

Hof is BusinessWeek's Silicon Valley bureau chief .

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