Monday, May 19, 2008 The Activist Investor: How Peanut Butter Lured Icahn to Yahoo!

Cross-posted from the May 19th

By Eric Jackson

05/19/08 - 06:59 AM EDT
LM MOT (Stocks Under $10 PICK) MSFT YHOO

They say that a butterfly flapping its wings in Asia can start a hurricane in West Africa.
Hurricane Carl arrived on the doorsteps of Yahoo!'s(YHOO - Cramer's Take - Stockpickr) offices Thursday, complete with his slate of 10 nominees to unseat Yahoo!'s entire board at the July 3 annual meeting. (And Icahn's entrance is no longer the latest twist in the Microhoo saga, as Microsoft approached Yahoo! with a new proposal on Sunday.)

The butterfly who started the chain of events that led to this is Brad Garlinghouse, a senior Yahoo! executive who penned the "Peanut Butter Manifesto" in November 2006.
Someone, not Brad himself, leaked the memo to Kevin Delaney of the Wall Street Journal and it put all of Yahoo!'s dirty laundry on the front page.

Garlinghouse wrote this memo (in the same vein as Jerry Maguire) which he sent internally to rally the troops. He criticized the company for spreading itself too thin and urged it to focus more: "We want to do everything and be everything - to everyone."

A few weeks prior to this memo's debut, I wrote a blog post criticizing Terry Semel for not be responsible for Yahoo!'s post-bubble turnaround, but as someone who was more along for the ride. Anemic traffic to my blog suddenly shot up. I also saw a wave of comments on the post from current or former Yahoo! employees agreeing with me.

The Peanut Butter memo seemed to be a cry for help. I expected that some activist hedge fund, like Icahn, Jana Partners, or Relational Investors, would be interested in Yahoo! because of its traffic, brand, and great properties overseas combined with an ineffective board and management.

They never came.

Next Yahoo! announced a December 2006 reorganization to show it was as nimble as ever. It was cosmetic. Meanwhile people kept pouring in their comments to my blog postings on what was wrong with Yahoo!, often referring to the Peanut Butter Manifesto as a final straw and suggesting action needed to be taken. I was inspired to start my own activism against the Internet giant.

In January 2007, I launched an Internet-based activist campaign encouraging frustrated Yahoo! shareholders to pool their shares with me in order to speak with one voice and push the company for significant changes in its board and management.

People immediately started "pledging" their shares towards our group. By last year's annual meeting, we had 100 shareholders with 2.1 million shares of Yahoo! stock. We ended up getting a lot of press and spoke to many large institutional holders encouraging them to vote against a significant number of the directors at the meeting. CEO Terry Semel stepped down 6 days after the vote.

Although most shareholders were pleased to have Jerry Yang take over as CEO last summer, he was slow out of the blocks and basically followed the path Semel had been going down. At his first analysts' call last July, Yang announced he needed 90 days to study the company from top to bottom before making changes.

Three months passed without acknowledgement. No news was bad news and Wall Street headed for the exits. Yahoo!'s stock declined from $34 in October to $19 in January of this year.
It took Microsoft's bid on February 1st to jolt Jerry to life. Suddenly talks were happening with Google, AOL, and News Corp. Had any of these discussions been happening sooner, Yahoo!'s stock would likely never have dropped to the levels which have now put in play.

It's no surprise Icahn showed up to this party. As Kara Swisher said, he smelled the blood in the water. The disappointment of shareholders was nearly universal following the breakdown in talks with Microsoft 2 weeks ago.

The thing that stuck in the craw of most Yahoo! investors wasn't the shock of Microsoft's abrupt termination of the talks two weeks ago, it was a New York Times article. The day after talks broke off, the Times reported that: "People close to Yahoo said that Mr. Yang and his team greeted Microsoft's decision as a victory. High-fives were exchanged Saturday afternoon when they learned Microsoft was backing down."

People close to Yahoo! have sworn to me that this absolutely never happened. But we're not talking about a rumor reported on Joe's Tech Blog here; this is the New York Times. I've spoken to Times reporter Miguel Helft about this detail and he stands by the paper's reporting. Be prepared to hear a lot about high-fives and peanut butter in the next few weeks.

Icahn will get a lot of support from the retail investors and the recent hedge funds and merger/arbs who have piled in to this stock in the past 10 days. John Paulson has already thrown his 50 million Yahoo! shares behind the dissidents.

Icahn's greatest challenge is going to be convincing some of the larger, more skeptical shareholders like Bill Miller of Legg Mason(LM - Cramer's Take - Stockpickr) and the other larger institutional players that he will get them a better price and not weaken Yahoo!'s negotiating position with Microsoft(MSFT - Cramer's Take - Stockpickr). Some have also said he doesn't have enough people with Internet experience on his slate.

In Icahn's first battle with Motorola(MOT - Cramer's Take - Stockpickr) last year, although he got support from several investors (including Brian Posner, who used to run ClearBridge Advisors and is now one of Icahn's nominees for the Yahoo! board), it wasn't enough to get elected. He's got a more enraged shareholder base this time around with Yahoo!, and he's running against a board that's delivered a big fat goose-egg in shareholder returns for the past 4 years. However, he's got to deliver a compelling case for how he and his team will create more shareholder value with or without Microsoft. He can't just run a campaign on the mistakes of the existing board (although there are many).

As a shareholder, I will be taking the next two weeks to listen to the 20 people up for election for the 10 seats around the board table. May the best group with the best plan to maximize Yahoo!'s price per share win.

What happens next? Yahoo!'s board knows that it's likely to be convicted on a charge of aggravated assault to its shareholders for the last 4 years. They will likely try to cut a deal with Icahn. Although I like fireworks, it wouldn't surprise me if discussions get restarted with Microsoft and a friendly deal gets reached prior to the Yahoo! annual meeting on July 3.

That would be less that two years after Brad Garlinghouse put his massive passion for and frustration with Yahoo! to paper. In this Internet age, ideas can inspire and spread like wildfire. Garlinghouse's memo was supposed to help Yahoo! save itself from the inside-out. Instead, his words, which have led to Carl Icahn's arrival, put the wheels in motion to save itself from the outside-in.

At the time of publication, Jackson was long YHOO and MOT.

Eric Jackson is founder and president of Ironfire Capital, LLC, and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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