The Curious Investor

We’ve all heard by now that Microsoft has made an offer to buy Yahoo! in a cash and stock deal that values Yahoo! at the upper bound of it 52-week range, $31 per share to be exact. And, while Yahoo shareholders disillusioned with the company’s performance might want to take the money and run, does this deal really make sense in the long run? There are really two lenses with which to view this deal. And, we’ll try to address both here.

Microsoft’s Take
Clearly, Microsoft is reeling from having missed the ball on the current internet revolution. And, as a result of failed attempts to revive MSN including a rather contrived and awkwardly executed re-branding to Windows Live, the company is now looking outside of its walls for ways to penetrate Google’s mighty fortress. Last year, it spent $6 billion to acquire aQuantive, the second biggest player in the internet behind DoubleClick. As a result of Google’s own internet advertising presence, the DoubleClick deal remains mired in red tape while the aQuantive deal has officially closed. Unfortunately, Microsoft’s advertising game is hampered by the fact that its internet reach is not quite as robust as either that of Yahoo or Google. Thus, the vast resources acquired in the aQuantive deal are difficult to unlock. And, that’s where Yahoo comes in.

Yahoo is a natural strategic fit for Microsoft’s catch up game in the internet. For one thing, Yahoo is currently profitable. Microsoft’s internet unit continues to operate at a loss posting a $245 million this quarter though this is partially inflated due to the aQuantive acquisition. Even with Yahoo, Microsoft does not stand to come to profitability within its internet division immediately.

As the company integrates, however, Microsoft can take advantage of Yahoo’s vast reach on the internet and help to unlock the value in its stake in aQuantive. Further, the two companies would be able to trim a lot of excess cost due to the fact that the two divisions ostensibly employ the same types of people working on very similar projects - Web 2.0 applications, the maintenance of current services, etc. Further, looking into the future, the combination of Yahoo’s network of users and Microsoft’s current stance as the pre-eminent offline software producer should provide a formidable boost for the launch of Microsoft’s new “Live” software and positioning them well in the battle for internet-enabled enterprise products like Office Live. In this sense, Google will have to really step up its forays into web-enabled software.

Granted, this is just the bright side of the coin. Given the redundancy of the MSN and Yahoo networks, both feature user communities, e-mail, similar shopping, news and finance portals, as well as a host of other user focused services, one cannot simply assume that the company will be able to retain their respective market shares in full. It is not as simple as adding Microsoft’s 9.8% U.S. search market share to Yahoo’s 22.9% market share. In fact, by the time integration is completed, it is not out of the realm of possibility that the Microsoft Internet Unit will only be able to retain Yahoo’s initial 22.9% market share.

On the note of integration, the addition of Yahoo to Microsoft will undoubtedly be a difficult task. While Microsoft claims to have a detailed integration plan in place, if efforts on its “Live” rebranding are any indication of what the detailed planning includes we might be looking at a debacle of Excite-Ask Jeeves proportions. Clearly, Microsoft does not believe this is the case and is salivating at the idea of being able to add Yahoo’s internet properties to its Internet Unit.

Yahoo’s Take
The Yahoo point of view is a bit more difficult to pinpoint. In fact, this deal is likely viewed in two ways. From a shareholder perspective, the deal is a no brainer in the short term. The stock is trading at its lowest levels since the bubble burst and Microsoft’s deal offers a 60% golden parachute for anyone not willing to stomach the company’s ongoing turnaround efforts. That being said, it is hard to say if a merger with Microsoft is within the longterm best interests of Yahoo’s operations.

As mentioned above, there are a lot of redundancies between the Microsoft and Yahoo networks and a combination requires that certain systems take precedence over others. Who will win out? Will this combined unit operate as “MSN/Windows Live” or as “Yahoo!, with a suite of Microsoft Web Products”? What of Yahoo’s recent acquisition of Web Office developer Zimbra and other similar attempts to add to its already impressive roster of net properties, services, and software? Overall, the popularity of Yahoo’s products like Flickr, Upcoming, and Hot Jobs will probably win out over many of Microsoft’s lesser used services. And, if that is the case, why not go it alone rather than wait to be dragged down by the weight of Microsoft’s struggling internet unit and increasingly less relevant offline franchise.

My Take
All-in-all, the Yahoo view of this deal is a very shortsighted one. Unless of course, Microsoft finds a way to dig deep and offer a lot more money. Microsoft’s current offer for Yahoo gives it a valuation in the range of Google’s (17x EBITDA and 40-45x Earnings) and, while Yahoo has struggled to monetize its online properties, the offer seems at best just a fair one. Yahoo is in the beginning stages of a turnaround and holds onto a truly impressive internet franchise. Prior to this offer, I was already contemplating taking a position in the company because I felt that it was being unfairly punished. Just a few changes in Yahoo’s structure and operations could likely bring this company back into the spotlight for internet portals with or without Microsoft and it remains to be seen whether or not Microsoft can survive without Yahoo. That kind of a bargaining position would seem to tell me that Yahoo ought to think long and hard about whether or not $45 billion is enough.

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