Monday, June 16, 2008 Activist Investor: Take the Third Option on Yahoo!


By Eric Jackson
06/16/08 - 08:06 AM EDT

The timing was impeccable when I opened my mail Friday and found Yahoo!'s(YHOO - Cramer's Take - Stockpickr) proxy statement with a cover note that started: "The vote you will cast for directors at Yahoo!'s August 1, 2008 annual meeting is the most important for stockholders in our history." I couldn't agree more.

Carl Icahn is seeking to oust the entire Yahoo! board at that meeting. There's been a barrage of letters and counter-letters between Icahn and Yahoo! Chair Roy Bostock in the last few weeks, and Yahoo! shareholders have been faced with a binary choice for their vote at the upcoming election. I want to outline and advocate for a Third Option.

To this point, Icahn has made the case that the current board bungled the negotiations with Microsoft(MSFT - Cramer's Take - Stockpickr), leaving a breath-taking amount of shareholder value on the table. They also approved an employment retention and severance package in February that was effectively a poison-pill, as it could tack on $2.6 billion to the price any acquirer would pay to buy company. Icahn argues this package was put in place to deter Microsoft and keep Yahoo! independent. Two reasons why Yahoo! might want to do this is (1) an emotional attachment the co-founders have for their company, and (2) the lavish senior executive and director compensation that has been paid out over the past few years. (The non-executive Yahoo! directors, on average, pay themselves twice as much as the non-executive Google directors -- $500,000 a year vs. $250,000, according to the most recent proxies from both companies.)

I am a Yahoo! shareholder and have pulled together a group of other Yahoo! shareholders with 3.2 million shares owned collectively (worth $74 million at today's prices). I happen to agree with Icahn's arguments and support his slate; so do most retail investors and smaller institutional and hedge fund investors, according to unscientific conversations I've had over the last 6 weeks.

Yahoo!'s argument for why the current directors should keep their jobs is that Icahn's team has no plan to operate the company if he wins. It also appears he has little leverage to bring Microsoft back to the negotiating table. They point to Icahn's existing suggestions to simply offer to sell the company to Microsoft for $34.375, fire Jerry Yang as CEO, and hire someone like Eric Schmidt as CEO. They and others have also criticized Icahn's slate as not having enough "Internet experience." They warn that Yahoo!'s newly approved "retention package" will kick in if Icahn wins 5 or more board seats in this proxy contest. Such an outcome would be classified as a change in control, meaning Icahn's new group couldn't change any employee's job description or location without potentially incurring up to a $2.6 billion fee (paid for by Yahoo! shareholders). Reading between the lines, Yahoo!'s board is saying: we know our four-year track record is poor and we understand the shareholder anger over us not consummating a deal with Microsoft, but you should still vote for us because we can operate this company better than Icahn and at less cost to you shareholders.

Let me be clear that I reject this argument. I have been seeking major changes to Yahoo!'s board since January 2007. Many other shareholders have wanted changes to Yahoo!'s board for some time. At last year's annual meeting, 36% of Yahoo! shareholders voted against the re-election of the three directors on the Compensation Committee, as well as high protest votes against every other director, in part due to mass frustration with the under-performance of this company.

However, I recognize that there are some large institutional shareholders who will be persuaded by Yahoo!'s argument over Icahn's argument.

More importantly, I fear that a majority will side with Yahoo!, just as a majority of large holders sided with Motorola(MOT - Cramer's Take - Stockpickr) management in May 2007 instead of Icahn, before the gravity of the company's problems fully showed themselves.

Therefore, this article is directed to those large holders in Yahoo! like Capital World Investors, Capital Research, Legg Mason(LM - Cramer's Take - Stockpickr), Vanguard, State Street(STT - Cramer's Take - Stockpickr), Citi Investment Research, Fidelity, BNY Mellon, and T. Rowe Price(TROW - Cramer's Take - Stockpickr). It is also directed to the large proxy advisory firms RiskMetrics, Glass Lewis, and ProxyGovernance.

A "Third Option"Here is a "Third Option" for how institutions can vote at Yahoo!'s annual meeting, if you cannot fully support the Icahn slate: vote in a minority of Icahn's representatives to Yahoo!'s board.

There are 9 spots up for election on this year's Yahoo! board. My "Third Option" would be to vote in 5 from the existing board and 4 nominees from Icahn's slate. Whichever 9 individuals gets the most number of votes will serve on the new board.

In doing so, you will ensure the following:

  • Change: After the company's last four years of poor performance and the great disappointment with the outcome of the Microsoft talks, shareholders clearly want change. This "Third Option" will create a new board. The old directors who remain will be more responsive and shareholder-friendly, as a result of a clear message being sent from this election.
  • Heightened Accountability to the Will of Shareholders: There will be full accountability within board meetings by ensuring that shareholders select four powerful new voices to sit around the table representing their interests
  • Removal of Impediments to a Future Acquisition: The costly $2.6 billion severance/ "poison pill" plan will not be triggered through a "change of control" provision and could be immediately rescinded by the new board after the election, so as not to deter future potential acquirers of Yahoo!
  • Operational Continuity: The operational continuity of the company will be assured. You will continue to have the existing management team in place (until the new board makes changes in the future as needed), as well as a majority of the current board to ensure a continuity of the issues which have been discussed and grappled with at the board level over the last year.

Neither side running for election can guarantee that Microsoft will ever come back to the table with an offer for Yahoo! We must accept that reality and select a board to do the best job in the current situation (even as distasteful as the situation is). This "Third Option" will clearly assure the best possible future outcome for shareholders vs. supporting only the incumbent Yahoo! board.

Which Yahoo! Directors Should Be Re-elected?

I endorse these five Yahoo! directors to remain on the board under this "Third Option" scenario, for reasons explained below:

  • Vyomesh Joshi, EVP from HP
  • Robert Kotick, Chair & CEO of Activision
  • Maggie Wilderotter, Chair & CEO of Citizens Communications
  • Gary Wilson, Private Investor
  • Jerry Yang, Co-Founder of Yahoo!

In my opinion, the current members of Yahoo!'s Compensation Committee (Chairman Bostock, Ron Burkle and Art Kern) should not be re-elected as they were each the subject of the highest "against" votes at last year's annual meeting. They are also responsible for ladling out excessive stock options to their fellow directors and senior executives over the last four years. I also believe that Eric Hippeau should not be re-elected because he, like Art Kern, has been on the board for over 12 years. That's simply too long, given the relatively poor performance of the company in these past four years. It is time for new blood.

Although I have been disappointed with the results of Jerry Yang's tenure as CEO and hold him accountable for the poor outcome with Microsoft, I believe that -- as a co-founder -- he should remain on this board. Whether or not he remains as CEO is something for the new board to determine. I frankly hold Mr. Bostock more responsible for the break-down in talks with Microsoft. He supposedly has much more experience in such deal-making matters than Yang, and I find it puzzling that he would choose not to attend that fateful May 3 meeting in Seattle, which led to Microsoft finally pulling the plug on their offer.

Which Icahn Nominees Should be Elected?

From Icahn's slate, there are many worthy candidates. However, I believe the best four candidates to serve on the new Yahoo! board are:

  • Adam Dell: The younger brother of Michael Dell, he is a Web venture capitalist. He has arguably the most "Internet experience" of anyone on Icahn's slate. He also knows Yahoo! well through selling HotJobs to the company.
  • Lucian Bebchuk: The Harvard professor and director of Harvard Law School's program on corporate governance. He is also an esteemed researcher and outspoken critic on excessive executive compensation. He would be the perfect antidote for what ails Yahoo! on that particular issue.
  • John Chapple: The former CEO of Nextel Partners, which he sold to Sprint. If nothing else, he understands the virtues (for his shareholders at least) of selling high rather than selling low. We would welcome such perspectives on Yahoo!'s board. He also brings Fortune 500 CEO experience to the board table.
  • Edward Meyer: The former CEO of large advertising agency Grey Global Group. Yahoo! needs to sell to advertisers like Grey if it is to have a future. Therefore, Meyer will ensure that perspective is represented on the new board.

Why shouldn't Icahn or his deputy Keith Meister be elected? I want Icahn to win outright, but I am putting forward this "Third Option" because I fear several large shareholders will worry about the operational abilities of Icahn and his team. As I said earlier, I support them and believe they are more than fit to serve on this board. Icahn has done a great service to Yahoo! shareholders by running this proxy contest. If he wasn't, we would only be able to vote for the existing board members.

But the "Third Option" is about electing a "short slate" of directors with highly relevant professional, industry, and research experience to make Yahoo!'s board better. These four nominees meet that criteria and will be, I believe, appealing to a majority of investors.
To move forward as Yahoo! shareholders, we need to turn the page with this "Third Option" and not remain stuck in the past with the existing failed board.

Most Yahoo! shareholders I've communicated with since the break-down in discussions between Microsoft and Yahoo! last week are still numb and angry.

From Feb. 1 to May 3, Yahoo! shares were valued at $31 (and briefly verbally valued at $33), before the bottom fell out of the talks.

Today, those shares are at $23, with no prospect of increased value in the foreseeable future. Yahoo! appears comfortable with its new deal to partially use the market monopolistic leader for paid search ads. Microsoft, and its 61% premium offer, appears to be gone, for now. Hence the need for this "Third Option."

At the time of publication, Jackson was long YHOO.

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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