Wednesday, June 04, 2008 The Activist Investor: Four Ways Icahn Can Beat Yahoo!


By Eric Jackson

06/04/08 - 09:12 AM EDT

Yesterday, Carl Icahn amped up the rhetoric in his battle to take control of Yahoo!'s(YHOO - Cramer's Take - Stockpickr) board, by calling for CEO Jerry Yang's head.

"I am amazed at the lengths that Jerry Yang and the board went to entrench themselves in this situation," said Icahn in the Wall Street Journal Tuesday. He added that he thought it was unlikely another bid by Microsoft(MSFT - Cramer's Take - Stockpickr) for Yahoo! would come as long as Yang was in charge.

So now that Yahoo! finally set the date for its annual meeting (Friday, Aug. 1 at the Fairmont in San Jose), the stage is set for 8 weeks of proxy fight fun.

Henry Blodget thinks Icahn's got a victory in the bag, saying he already has support from 30%+ of Yahoo! stockholders. He points to assumed support from Capital Research (due to previously critical comments made by Gordy Crawford of Yahoo!'s "so-called" independent board) and Legg Mason (LM - Cramer's Take - Stockpickr) (for similar reasons) and confirmed support from hedge fund heavyweights T. Boone Pickens, John Paulson, and Dan Loeb.

The problem with this math is that Gordy Crawford doesn't vote Capital Research's 16% Yahoo! stake himself. He oversees 6 of that 16%. The balance is overseen by Capital World Investors, which is led by Mark Casey in San Francisco. Cap World will vote for the path that will lead to the highest price per share. Legg Mason and many other larger institutional holders will also take a "show me" attitude to why Icahn's team will get them more money over the existing board.

I disagree with the "show me" line of thought and support Icahn's slate. As far as I'm concerned, after Yahoo!'s last four year's of slipped deadlines, missed opportunities and chronic market under-performance, the burden of proof should lie on the shoulders of the incumbent board and not an activist investor's slate that easily passes a credibility sniff test.

Icahn can win this proxy fight. Here's four steps he should take to ensure it:

1. Recount the Board's Many Mistakes: Icahn's biggest advantage in this battle is the horrible track record of Yahoo!'s board. It would be different if the botched Microsoft negotiations were a one-off. But Yahoo! has been in serious decline for four years. They've overseen a zero percent return for the shareholders over that time. They also monitored Yahoo! taking a pass on buying Google, Facebook, YouTube, and DoubleClick. The company's foray into becoming a mini-Hollywood studio was an aimless walk in the desert for years. And they also watched the company slowly integrate Overture's pioneering paid search technology, allowing Google to surge ahead of them for good.

Supporters of Yahoo!'s board say that they have more relevant Internet experience than Icahn's slate. What good is Internet experience if you've presided over so many mistakes for so long? What good is having supposed deal-makers like Chairman Roy Bostock and others on this board if they haven't been able to consummate a deal?

2. Point out Jerry Yang and the Management Team as In Over Their Heads and Co-Creators of the Problems: Jerry Yang and President, Sue Decker, appeared last week at the All Things D Conference last week in Carlsbad, Calif., looking solemn and lacking any energy or clarity in explaining what Yahoo! does and what it wants to be assuming it stays independent.
This management team had more than seven months after Terry Semel resigned and before Microsoft launched its offer to set Yahoo! on a new course. They didn't do it, choosing instead to pretty much stay the course Terry had been on. In retrospect, it's not surprising, as Yang, Decker, David Filo, Brad Garlinghouse, and Jeff Weiner are long-timers.

How can this team be entrusted to fix Yahoo!, when they were the ones who broke Yahoo!?

3. Raise the Issue of Director and Executive Compensation: Executive Compensation has dogged Yahoo! as an issue for years. Shareholder ire on this was typically directed at Terry Semel and the Compensation Committee who paid him. Yahoo! was handing out top decile pay for market under-performance in the last years of his tenure.

You might have thought that the issue would die when Semel agreed to step down last year, after each of the Comp Committee directors (Bostock, Ron Burkle, and Art Kern) received 35% of shareholders votes cast against their re-election.

A quick comparison of Yahoo!'s newly released preliminary proxy and Google's from several months ago shows that Yahoo!'s independent directors were paid, on average, nearly twice as much in total compensation last year as Google's independent directors ($497,812 vs. $260,854).

All of this compensation was paid out in stock grants and stock options, yet these lavish packages have an economic cost to current stockholders. This isn't play money. It's painful to Yahoo! shareholders to think that these board members were paid $4.4 million last year collectively and that led to these kinds of results.

Yahoo! directors and officers continue to be addicted to excessive stock compensation.

4. Prove You Can Get a Higher Price for Yahoo! than its Foot-Dragging and Feigned Indifferent Board: This is the biggest nut that Icahn must crack in the eyes of key swing voters. He is unlikely to get public support from Microsoft in advance of the Aug. 1 meeting. So, on his own, he will have to articulate how he can get more for shareholders than the other guys. Without a firm offer from Microsoft in hand, some shareholders will simply not believe Carl.

However, enough shareholders can and will support Icahn if he points to how he's knocked heads before to get a better deal done (BEA and Oracle being the most recent and relevant example).

He can also always turn this critique around to ask why the existing board has persistently turned its nose up at a potential deal with Microsoft (according to recent unsealed documents coming out of the shareholder Delaware Chancery Court case against Yahoo!).

There are many reasons why Icahn might not want to win this proxy contest.

Thanks to Yahoo!'s Feb. 12 approval of poison pill-like "Change of Control" provisions, Icahn himself could trigger these if he wins five or more board seats.

The new leadership of Yahoo! would be hamstrung from changing anyone's job titles without expensive severance, benefits, accelerated vesting, and other services kicking in. There would also be rapid departure of the most senior and expensive executives.

It's not right, but this scenario will factor into to Capital World's and Legg's thought process as they weigh how to vote their shares.

There's a clear solution for all parties involved: get a deal with Microsoft done before Aug. 1.

Yahoo!'s directors don't want further embarrassment to mar their reputations. Icahn and other Yahoo! shareholders can get back to a full and fair price for their shares. And Microsoft can get out of their two-year Yahoo! purgatory (since they first privately floated the idea of a deal in mid-2006 to Yahoo!) and get on with beefing up their anemic Online Services Division and protecting their core Desktop cash cow with Web services and advertising revenue.

[Disclosure: At the time of publication, Jackson was long Yahoo!]

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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