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Archive for February 23rd, 2008

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News Analysis February 1, 2008, 11:01PM EST text size: TT

Microsoft and Yahoo!: Happily Ever After?

If the No. 2 and No. 3 Web search titans tie the knot—via Microsoft’s multibillion-dollar bid for Yahoo—they may only just keep up with No. 1, Google

https://i1.wp.com/images.businessweek.com/story/08/600/0201_msoft.jpgKevin Casey/Getty Images

Having spent north of $10 billion buying and building a Web business, Microsoft (MSFT) finally acknowledged its best efforts have done nothing to stall Internet leader Google (GOOG). On Feb. 1, the software giant took its most audacious step yet, announcing an unsolicited $44.6 billion bid for online rival Yahoo! (YHOO).

The deal would combine the second- and third-largest players in Web search. For Microsoft, it may be something of a Hail Mary pass, a last best attempt to catch Google while it still can. “We have been making good progress,” says Microsoft CEO Steven Ballmer. “We’re in this game, and we’re going to be in this game. But the market leader is getting stronger.”

Microsoft offered a 62% premium on a share price that’s been sliding for the better part of a year amid five consecutive quarters of profit declines. So the overture will be hard to resist and a rival bid is unlikely. Some analysts said the deal makes strategic and financial sense, especially for Yahoo. The company’s stock surged 48% to $28.38.

Still, whether and how quickly a combined Microsoft and Yahoo can mount a meaningful counteroffensive against Google is by no means clear. The cost savings won’t be easy to achieve in an economy veering toward recession, the companies will struggle to elegantly combine disparate operations, and Google can be expected to use the time to lengthen its lead in the quickly growing online ad market. Regulators will probably approve the deal, but not before a lengthy review that could involve imposing conditions aimed at ensuring competition.

Microsoft vs. Dominant Competitor

Microsoft believes it can eke out $1 billion a year in cost savings from the combined operations. Anant Sundaram, a professor at Dartmouth’s Tuck School of Business who has studied mergers and acquisitions, says that may be ambitious. “With the economy looking increasingly wobbly, it is not clear that the revenue synergies will start to happen any time soon,” Sundaram says.

Ballmer’s keen awareness of that deterioration was evident in a Jan. 31 letter to Yahoo CEO Jerry Yang. Ballmer noted the two had discussed partnerships in late 2006 and early 2007 but that in light of Yahoo’s worsening outlook, “the only alternative now is the combination of Microsoft and Yahoo! that we are proposing.” Yang even rejected merger overtures in February, 2007, Ballmer wrote, hoping a new ad strategy and reorganization would brighten prospects. “A year has gone by, and the competitive situation has not improved,” Ballmer wrote.

There’s little doubt that Microsoft’s interest in Yahoo has grown more fervent as Google’s lead has increased. The battle to catch Google grows harder by the day. “I think Microsoft is desperate,” says Forrester Research (FORR) analyst Charlene Li.

In Google, Microsoft sees a foe that is very much like the one it was in the early days of personal computing. Back in the 1980s and ’90s, Microsoft created what’s known as a network effect, whereby a service becomes more valuable as more people use it, with its Windows operating system. The more people used it, the more applications got written for it. That made Windows ever more appealing to computer users, ultimately helping the company garner more than 90% of the operating system business.

Benefit to Advertisers Unclear

In online search and advertising, Google is having a comparable impact. As more people search the Web using Google, its search results become more relevant. That in turn makes advertising through Google all the more appealing to marketers. Google not only sells ads to accompany search results, but it is also becoming an online ad network, serving as the go-between for advertisers and site publishers across the Web. Web publishers increasingly turn to Google’s network to sell ad space because the company has the largest collection of advertisers interested in buying.

Microsoft hopes to diminish Google’s advantage through the Yahoo acquisition. If Microsoft can smoothly mesh Yahoo into its MSN and Windows Live Internet businesses, it could create a network that approaches Google’s size. Google accounted for 56.3% of all Web searches in December, compared with a combined 31.5% for Microsoft and Yahoo, according to Nielsen Online. A combined Microsoft and Yahoo would “bring together critical mass,” Ballmer says, and “we’ll build off that strength.”

It’s unclear, though, whether advertisers prefer a single strong rival to Google or two lesser companies fighting for their business. Increasingly, advertisers are looking at smaller sites to target their ads, says Jarvis Coffin, co-founder and CEO of Burst Media (BRST.L), an ad network that helps place ads for such brands as Alamo, Disney (DIS), and ESPN. Getting together won’t make Microsoft and Yahoo “more responsive to what the market is looking for and what consumers are looking for online,” Coffin says. “It isn’t going to make it any more relevant and powerful for advertisers.”

What’s more, smoothly integrating operations will be difficult for two such large companies with disparate businesses and clashing cultures. Microsoft and Yahoo have been gobbling up online businesses, including online ad firms aQuantive, bought by Microsoft, and Right Media, acquired by Yahoo. “They’ve really bitten off quite a bit to digest,” says Kevin Lee, executive chairman of Didit, a digital marketing firm. “It would be quite an undertaking to combine all those pieces.”

Messy Overlap of Businesses

Then, Microsoft will also have to figure out how to meld the Yahoo brand into its own stable of online businesses. “There’s no doubt that Yahoo, the brand, lives,” Ballmer says. Microsoft has already stumbled trying to operate its two online brands—MSN and Windows Live. Now it will need to add a third brand that’s arguably stronger.

And then there’s the challenge of figuring out what to do with overlapping Web sites and services—from the companies’ automotive buying pages to their portals to their Web-based e-mail programs to their instant messaging services. “It’s a mess,” says Forrester’s Li. “Users are notoriously fickle. One change and they’re gone.”

And, of course, Google won’t be sitting idly as Microsoft addresses those challenges. “They’re going to be doing this in the face of a very aggressive competitor,” Li says.

A merger between Microsoft and Yahoo made much more sense three years ago, before Microsoft built and bought its online empire, says SearchEngineLand.com editor Danny Sullivan. Now, there’s so much overlap that the cost has grown exponentially. And Microsoft will have its hands full figuring out how to put the businesses together. “It probably still makes sense now, but it’s a much more challenging process,” Sullivan says.

The deal would eclipse Microsoft’s largest acquisition—the August, 2007, purchase of online ad firm aQuantive—by sevenfold. And it would drain the $21.1 billion that Microsoft had in cash as of Dec. 31, since Microsoft plans to pay for half of the deal with cash and the remainder in stock. Microsoft generates more than $1 billion a month in free cash, so its coffers could be restored in short order.

While Microsoft shares dipped on the news, falling 6.6% to $30.45 on Feb. 1, Sanford C. Bernstein analyst Charles Di Bona believes shareholders will come around. Microsoft built assets like its adCenter online advertising platform to compete with Google. But it wasn’t able to leverage those offerings with the relative smattering of users it had. “What they are admitting is that they can’t monetize those assets without a sizable community,” Di Bona says.

Regulatory and Cultural Hurdles

Yahoo executives still might balk at the deal. They have been cool to the idea of selling out because they believe they have the pieces in place, such as a base of 500 million monthly visitors, improved search-advertising technology with the year-old Panama project, and new display-ad targeting technology from last year’s acquisitions of Right Media and BlueLithium, to return to some semblance of its former glory. But after a fourth quarter in which it announced a muted outlook for 2008, knocking its stock down 8.5% on Jan. 30, its leverage was fading. In a statement, Yahoo said it would “evaluate this proposal carefully and promptly in the context of Yahoo’s strategic plans and pursue the best course of action to maximize long-term value for shareholders.”

Assuming Yahoo agrees, Microsoft will still need to get the deal past regulators. The company believes the acquisition will stand up to the regulatory scrutiny. The House Judiciary Committee said on Feb. 1 it will hold a hearing to discuss the proposed merger on Feb. 8. While congressional leaders don’t have the power to block planned acquisitions, their attention to such matters can influence the regulatory bodies that do.

In a statement, the antitrust division of the U.S. Justice Dept. said it is “interested in looking at the competitive effects of the proposed transaction.” Given the DOJ and Federal Trade Commission’s recent history of approving billion-dollar ad network deals, many believe the merger will ultimately be approved.

Maybe the biggest challenge Microsoft will face is cultural. Yahoo’s 14,300 employees come largely from the Silicon Valley world that loves to hate Microsoft. “Yahoo has always considered itself a bit of an upstart,” says a former Yahoo employee who asked to remain anonymous. “Most Yahoo employees will feel that, A., we lost, and B., there is no way in hell that I am going to work for Microsoft.”

Greene is BusinessWeek‘s Seattle bureau chief.
With Catherine Holahan in New York and Robert D. Hof in Silicon Valley.

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Technology February 1, 2008, 9:36AM EST text size: TT

Ballmer’s Letter to the Yahoo Board

Microsoft Chief Executive Steve Ballmer outlines his company’s $44.6 billion offer to acquire Yahoo

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January 31, 2008

Board of Directors
Yahoo! Inc.
First Avenue
Sunnyvale, CA 94089
Attention: Roy Bostock, Chairman
Attention: Jerry Yang, Chief Executive Officer

Dear Members of the Board:

I am writing on behalf of the Board of Directors of Microsoft to make a proposal for a business combination of Microsoft and Yahoo!. Under our proposal, Microsoft would acquire all of the outstanding shares of Yahoo! common stock for per share consideration of $31 based on Microsoft’s closing share price on January 31, 2008, payable in the form of $31 in cash or 0.9509 of a share of Microsoft common stock. Microsoft would provide each Yahoo! shareholder with the ability to choose whether to receive the consideration in cash or Microsoft common stock, subject to pro-ration so that in the aggregate one-half of the Yahoo! common shares will be exchanged for shares of Microsoft common stock and one-half of the Yahoo! common shares will be converted into the right to receive cash. Our proposal is not subject to any financing condition.

Our proposal represents a 62% premium above the closing price of Yahoo! common stock of $19.18 on January 31, 2008. The implied premium for the operating assets of the company clearly is considerably greater when adjusted for the minority, non-controlled assets and cash. By whatever financial measure you use—EBITDA, free cash flow, operating cash flow, net income, or analyst target prices—this proposal represents a compelling value realization event for your shareholders.

We believe that Microsoft common stock represents a very attractive investment opportunity for Yahoo!’s shareholders. Microsoft has generated revenue growth of 15%, earnings growth of 26%, and a return on equity of 35% on average for the last three years. Microsoft’s share price has generated shareholder returns of 8% during the last one year period and 28% during the last three year period, significantly outperforming the S&P 500. It is our view that Microsoft has significant potential upside given the continued solid growth in our core businesses, the recent launch of Windows Vista, and other strategic initiatives.

Microsoft’s consistent belief has been that the combination of Microsoft and Yahoo! clearly represents the best way to deliver maximum value to our respective shareholders, as well as create a more efficient and competitive company that would provide greater value and service to our customers. In late 2006 and early 2007, we jointly explored a broad range of ways in which our two companies might work together. These discussions were based on a vision that the online businesses of Microsoft and Yahoo! should be aligned in some way to create a more effective competitor in the online marketplace. We discussed a number of alternatives ranging from commercial partnerships to a merger proposal, which you rejected. While a commercial partnership may have made sense at one time, Microsoft believes that the only alternative now is the combination of Microsoft and Yahoo! that we are proposing.

In February 2007, I received a letter from your Chairman indicating the view of the Yahoo! Board that “now is not the right time from the perspective of our shareholders to enter into discussions regarding an acquisition transaction.” According to that letter, the principal reason for this view was the Yahoo! Board’s confidence in the “potential upside” if management successfully executed on a reformulated strategy based on certain operational initiatives, such as Project Panama, and a significant organizational realignment. A year has gone by, and the competitive situation has not improved.

While online advertising growth continues, there are significant benefits of scale in advertising platform economics, in capital costs for search index build-out, and in research and development, making this a time of industry consolidation and convergence. Today, the market is increasingly dominated by one player who is consolidating its dominance through acquisition. Together, Microsoft and Yahoo! can offer a credible alternative for consumers, advertisers, and publishers.

Synergies of this combination fall into four areas:

Scale economics: This combination enables synergies related to scale economics of the advertising platform where today there is only one competitor at scale. This includes synergies across both search and non-search related advertising that will strengthen the value proposition to both advertisers and publishers. Additionally, the combination allows us to consolidate capital spending.

Expanded R&D capacity: The combined talent of our engineering resources can be focused on R&D priorities such as a single search index and single advertising platform. Together we can unleash new levels of innovation, delivering enhanced user experiences, breakthroughs in search, and new advertising platform capabilities. Many of these breakthroughs are a function of an engineering scale that today neither of our companies has on its own.

Operational efficiencies: Eliminating redundant infrastructure and duplicative operating costs will improve the financial performance of the combined entity.

Emerging user experiences: Our combined ability to focus engineering resources that drive innovation in emerging scenarios such as video, mobile services, online commerce, social media, and social platforms is greatly enhanced.

We would value the opportunity to further discuss with you how to optimize the integration of our respective businesses to create a leading global technology company with exceptional display and search advertising capabilities. You should also be aware that we intend to offer significant retention packages to your engineers, key leaders and employees across all disciplines.

We have dedicated considerable time and resources to an analysis of a potential transaction and are confident that the combination will receive all necessary regulatory approvals. We look forward to discussing this with you, and both our internal legal team and outside counsel are available to meet with your counsel at their earliest convenience.

Our proposal is subject to the negotiation of a definitive merger agreement and our having the opportunity to conduct certain limited and confirmatory due diligence. In addition, because a portion of the aggregate merger consideration would consist of Microsoft common stock, we would provide Yahoo! the opportunity to conduct appropriate limited due diligence with respect to Microsoft. We are prepared to deliver a draft merger agreement to you and begin discussions immediately.

In light of the significance of this proposal to your shareholders and ours, as well as the potential for selective disclosures, our intention is to publicly release the text of this letter tomorrow morning.

Due to the importance of these discussions and the value represented by our proposal, we expect the Yahoo! Board to engage in a full review of our proposal. My leadership team and I would be happy to make ourselves available to meet with you and your Board at your earliest convenience. Depending on the nature of your response, Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo!’s shareholders are provided with the opportunity to realize the value inherent in our proposal.

We believe this proposal represents a unique opportunity to create significant value for Yahoo!’s shareholders and employees, and the combined company will be better positioned to provide an enhanced value proposition to users and advertisers. We hope that you and your Board share our enthusiasm, and we look forward to a prompt and favorable reply.

Sincerely yours,

/s/ Steven A. Ballmer

Steven A. Ballmer
Chief Executive Officer
Microsoft Corporation

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News Analysis February 1, 2008, 8:31AM EST text size: TT

Microsoft Swoops In on Yahoo

The software king, with its $44.6 billion bid for the portal, wants to catch Google in the ballooning online ad market

Concluding that neither company can successfully take on Google by itself, Microsoft (MSFT) launched an unwelcome takeover bid for Yahoo (YHOO). Microsoft said Feb. 1 it will pay $44.6 billion, or $31 a share, for Yahoo. The offer represents a 62% premium over Yahoo’s closing share price Jan. 31.

The deal would marry the world’s largest software maker with the owner of the most used Internet portal, helping the resulting company better grapple with Google (GOOG) in a market for online advertising that’s expected to balloon to $80 billion by 2010.

Though Google’s name was scarcely mentioned during a Feb. 1 conference call discussing the deal, it was clearly the 800-pound motivation for Microsoft’s overture. “This market continues to grow and the leader continues to consolidate position,” Microsoft Chief Executive Officer Steven Ballmer said during the call. Ballmer said he called Yahoo CEO Jerry Yang the night before to make the offer and has been pursuing the deal for 18 months. “Our companies really do share a vision for online services and advertising,” Ballmer said during the call before U.S. markets opened. “There is no better way to increase scale and capacity than this acquisition.”

No Improvement After a Year

In late 2006 and early 2007, Microsoft and Yahoo discussed ways to work together, including through a merger, Ballmer noted in a letter to Yahoo’s board Jan. 31. Yahoo spurned the overtures, pointing to the “potential upside” of various efforts to improve its performance, including an effort to wring more profit from online advertising, Ballmer wrote. “A year has gone by, and the competitive situation has not improved,” Ballmer said.

By some estimates, 42% of all online advertising dollars go through Google. Microsoft, Yahoo, and Time Warner’s (TWX) AOL, combined, grab roughly the same percentage of the market, according to Jeffrey Rayport, founder and chairman of Marketspace Advisory, a strategy consulting firm. Some analysts said the transaction would help Yahoo and Microsoft compete with Google.

“Yahoo is under enormous pressure to realize value, and such a deal would serve this purpose,” Standard & Poor’s analyst Scott Kessler, who covers Internet companies, wrote in a research note to clients Feb. 1. Jim Yin, who covers software for S&P, said the deal “would help Microsoft compete more effectively against Google in search-engine and online advertising,” though he added, “The merger presents integration challenges.” (Like BusinessWeek.com, S&P is owned by The McGraw-Hill Cos. (MHP).)

Improving Economies of Scale

Google has steadily increased its share of online ad dollars during the past few years. That’s due in large part to the sheer number of people reached every day by Google and the ads it shows. The company is the dominant place people go to look up information—it hosts more than 60% of Web searches—and partnerships with leading social networks such as News Corp.’s (NWS) MySpace have allowed it to extend its reach even further.

With Yahoo, Microsoft would greatly expand the number of people who visit its network and the sites on which it can serve ads, enabling it to counter Google’s reach. “This is a business that has scale economics in the search and advertising industry,” said Kevin Johnson, president of Microsoft’s platforms and services division.

Microsoft also sees the deal as giving it the engineering power to fuel innovations on the Web. Both Microsoft and Yahoo have been criticized as innovation-stagnant compared to Google, which continually releases new products, and boasts of giving technical employees one day a week to work on new ideas. “By combining our engineering talent we are going to enable more innovation over a wider range,” said Johnson.

Savings on Capital Expenditures

Online publishers want a strong competitor to Google and therefore support the combination, Microsoft general counsel Brad Smith said on the call. “They’re encouraging us to make this kind of acquisition,” he said.

Microsoft says it would be able to reduce costs by $1 billion a year through the combination. The enlarged entity would be able to cut back on some capital-intensive efforts, such as building massive data centers. Microsoft expects to see earnings per share of break-even or better by the second half of 2008.

Microsoft executives spoke little of the mass layoffs that would likely be demanded if the two companies combined. Microsoft executives said the new management teams would consist of key people from both companies. However, Yahoo’s workforce of 14,300 would undoubtedly be reduced as Microsoft combined similar projects and departments that once competed with one another.

Corporate Cultural Differences

Yahoo began reducing its own staff, and combining redundant efforts, late last year, after founder Yang took over as CEO. It announced plans earlier this week to lay off 1,000 employees.

The integration of such a massive company will not be easy for Microsoft. Yahoo has a distinct culture, comparable in some respects to a media company, that many see as vastly different from the more buttoned-up Microsoft. But it’s just that kind of culture that Microsoft may be trying to adopt as it focuses more on the Web, looking toward a future in which even desktop applications such as Microsoft Word are served over the Internet. “It’s a transformation of our business,” says Ballmer.

With Jay Greene in Seattle and Robert D. Hof in Silicon Valley

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Special Report February 11, 2008, 9:37AM EST text size: TT

Yahoo’s High-Stakes ‘No Thanks’

Whether Yang & Co. want to stay independent or are holding out for a higher bid, their rejection of Microsoft’s offer is fraught with risk

https://i1.wp.com/images.businessweek.com/story/08/600/0211_yahoo.jpgA Yahoo billboard on Sixth Street in San Francisco. David Paul Morris/Getty Images

Web pioneer Yahoo (YHOO) has resisted the urge to merge with Microsoft (MSFT) for more than a year. But with its latest refusal Yahoo is playing a dangerous game.

Founder and Chief Executive Jerry Yang says that Microsoft’s Jan. 31 bid, worth $44.6 billion at the time, “substantially undervalues” Yahoo. In a statement released Feb. 11, Yahoo’s board cited the company’s “global brand, large worldwide audience, significant recent investments in advertising platforms and future growth prospects, free cash flow and earnings potential, as well as our substantial unconsolidated investments.” Microsoft, the argument goes, is seizing on the drop in Yahoo’s stock to buy the company on the cheap.

Yang and Yahoo are hoping Microsoft will sweeten a bid that was 62% higher than Yahoo’s Jan. 31 stock price. But a backfire in the gamesmanship could lead to a phalanx of shareholder lawsuits arguing the board is placing its interests ahead of those of investors. Typically, shareholder suits argue, in part, that directors prefer independence to protect their well-paying board seats.

In fact, the legal battle has already begun. When Microsoft made its public bid for Yahoo, CEO Steven Ballmer disclosed that he had proposed acquiring the company more than a year earlier, only to be rebuffed. That disclosure triggered a shareholder lawsuit last week in Santa Clara County (Calif.) Superior Court that accused Yahoo directors of failing to negotiate with Microsoft, and of entrenching themselves in order to continue to receive their board compensation.

Would Microsoft Offer More?

To be sure, Yang’s letter is certainly part of the ritualistic mating dance common to unsolicited takeover bids. But in this case, it’s also a high-stakes gamble. By all accounts, Yahoo has no other suitors, certainly none at Microsoft’s lofty valuation. If Microsoft were to walk away, rather than increase its bid, Yahoo’s share price would inevitably drop back from the 29.20 it closed at on Feb. 8 into the high-teens, where it traded before the offer. That would set off an avalanche of lawsuits with far more meat than the recently filed Santa Clara County case.

What’s more, Yang & Co. also have to worry about the state of the U.S. economy, which seems to be spiraling toward a recession. That would likely dampen online advertising prospects, which would hinder Yahoo’s hopes to rebound on its own. In the most recent quarter, Yahoo’s profits fell 23%. Yang may believe he can keep the company independent. But it’s just as likely that he’s hoping for Microsoft to boost its bid. Microsoft is a moneymaking machine, adding more than $1 billion a month to its cash holdings, which hit $21.1 billion Dec. 31, from its twin dominant Windows and Office software properties. And while Microsoft plans to borrow funds to close the deal—a first for the company—its credit quality is presumably so strong that the debt won’t be particularly costly. Moreover, when Ballmer announced the deal, he also stressed the importance of closing quickly, with search leader Google (GOOG) getting stronger by the day. That, too, may argue for bumping up the offer.

How high could Microsoft go? Some analysts have speculated that Microsoft is prepared to bid into the mid-30s, though Yahoo could be seeking as much as $40 a share. That would be a nearly one-third bump over Microsoft’s initial bid. With Microsoft’s stock sliding 12% since making the offer, to 28.56 on Feb. 8, it’s hard to imagine the company boosting its cash-and-stock offer by that much. Microsoft didn’t immediately comment on Yahoo’s rejection.

Yahoo doesn’t set a minimum price in the letter, but the board clearly is mindful of recent investments that include last year’s purchase of the outstanding shares of Right Media, which handles Web-ad placement, and the March, 2005 acquisition of popular photo-sharing site Flickr. Yahoo and analysts have valued the company’s holdings in China’s Alibaba, Yahoo Japan, and Gmarket in Korea alone at about $10 a share.

Proxy Fight Ahead?

Microsoft’s other alternative is to play hardball and take its case directly to shareholders. Microsoft is no stranger to playing rough. Indeed, making its bid public, even in the polite tones of Ballmer’s letter, was an aggressive tack that forced Yang into a corner.

Consider the threat Ballmer laid out in his Jan. 31 letter to Yang. “Depending on the nature of your response,” he wrote, “Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo’s shareholders are provided with the opportunity to realize the value inherent in our proposal.”

What steps? The most likely is Microsoft nominating a slate of directors to Yahoo’s board who would be partial to its bid. And the timing of the offer suggests that Microsoft is preparing to do just that. That’s because, according to Yahoo’s bylaws, shareholders have a 30-day window, starting Feb. 13, to nominate candidates for election to the company’s board at the annual meeting. It’s a powerful option since all 10 of Yahoo’s directors are up for election this year; Microsoft could take control of the company through a proxy fight.

State of the Shares

The outcome of such a battle, of course, depends on shareholder sentiment. But there are already signs that Yahoo investors are weary of the company’s sagging fortunes on Wall Street and are keen to taking Microsoft’s money. Eric Jackson, a management consultant, launched a small but well-covered “Yahoo Plan B” last year that sought, in part, to oust former CEO Terry Semel. He has just launched a new campaign calling for shareholders to negotiate with Microsoft directly. “This board is playing chicken with our shares,” he says. “We’re not going to sit back and watch the stock price crater to $17.”

Jackson is but one voice, and it is unclear how many shares he represents. But Microsoft would likely find support elsewhere, particularly from hedge fund managers who presumably have jumped into Yahoo shares since Microsoft made its public bid. About half of Yahoo’s shares have turned over since the offer, and it’s a fair assumption that much of that comes from speculators looking to arbitrage. If so, those aren’t investors planning to hold the shares long-term, betting on Yahoo’s independence.

Yang is fighting Microsoft’s courtship. But it appears less and less likely that he’ll keep Microsoft at bay.

Greene is BusinessWeek‘s Seattle bureau chief. Hof is BusinessWeek‘s Silicon Valley bureau chief .

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Saturday, February 23, 2008

Special Report

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Special Report February 12, 2008, 12:01AM EST text size: TT

The Microsoft-Yahoo! Mating Dance

Understanding the ins and outs of the brewing takeover battle requires parsing what each company said—and what each didn’t

Microsoft (MSFT) isn’t happy with Yahoo’s (YHOO) decision to spurn its $44.6 billion takeover bid, but the software maker is going to let Yahoo! live with the consequences a while before applying added pressure.

Microsoft said as much, however politely, on Feb. 11 when it called the offer, extended on Jan. 31, “full and fair.” The remarks came in response to Yahoo’s earlier statement that Microsoft’s bid “substantially undervalues” the company. The interchange is part of a delicate dance that, while cordial now, could soon turn hostile. “The process is following a reasonably well-known mating ritual,” says Joseph Grundfest, a Stanford Law School professor and former commissioner of the Securities & Exchange Commission.

To understand the process, it’s important to parse each company’s statement for what has been said and, just as important, what hasn’t. For example, Yahoo’s statements suggest there is a price that fairly values the company and ostensibly would be acceptable. Microsoft just hasn’t hit that number yet.

Passing the Buck to the Board

Importantly, Yahoo says it’s the company’s board that believes Microsoft’s bid undervalues it. The company didn’t say bankers or legal advisers feel that way. It leaves open the question whether the bankers at Goldman Sachs (GS), Lehman Brothers (LEH), and Moelis & Co., which are advising Yahoo, concur. The same goes for Yahoo’s attorneys at Skadden, Arps, Slate, Meagher & Flom.

What’s more, nowhere in Yahoo’s release does the company describe Microsoft’s offer as “inadequate.” That’s a key word, loaded with legal meaning that in mergers-and-acquisitions-speak could torpedo the deal. Instead, the company said only that “the proposal is not in the best interests of Yahoo and our stockholders.”

There’s even a line in the Yahoo statement that could suggest the company is ready to sell if Microsoft ups the ante. Yahoo says the board remains “committed to pursuing initiatives that maximize value for all stockholders.” That could be an invitation to increase the offer, something many analysts expect Microsoft to eventually do.

Reserving the Right to Go Hostile

There’s some parsing to do with the Microsoft statement as well. In its statement, Microsoft says it’s “unfortunate that Yahoo has not embraced our full and fair proposal.” That suggests Microsoft isn’t interested in offering more, at least not yet. Without any competitive offer or any alternative plan from Yahoo, there’s little need to rush on that point.

What if Yahoo does nothing? Well, Microsoft says it “reserves the right to pursue all necessary steps.” Of course, that’s the threat of going hostile. That means taking matters directly to shareholders. To do so, Microsoft would most likely file an exchange offer with securities regulators that outlines its stock-and-cash bid for Yahoo. That’s made more difficult by Yahoo’s “poison pill” defense, which gives shareholders the ability to buy stock at a significant discount if an unwanted bidder buys 15% or more of its shares.

To get around that, Microsoft would also have to replace the majority of Yahoo’s board with a group that wants the deal. That takes a proxy fight. Microsoft would have to nominate a slate of directors to be voted on at Yahoo’s annual meeting. According to Yahoo bylaws, shareholders can submit matters for the meeting any time from Feb. 13 to Mar. 13. Last year’s meeting was held in June.

There’s still time before Microsoft needs to go that route. If Yahoo is indeed just looking for more money, Microsoft certainly has the financial wherewithal to pony up. And that too is standard operating procedure in corporate courtship. “If the telephone call doesn’t work, you send flowers. Then you send candy,” Stanford’s Grundfest says. “And if that still doesn’t work, you might suggest that you are carrying a gun. But the question then is whether you are willing to pull it out and whether it is indeed loaded.”

Greene is BusinessWeek‘s Seattle bureau chief.

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The Associated Press February 3, 2008, 7:40PM ET text size: TT

Microsoft-Yahoo could skip culture clash

Yahoo’s walls are awash in bright purples and yellows, while Microsoft’s campus is coated in drab neutrals. Yahoo’s co-founder holds the cutesy title of “chief Yahoo,” while Bill Gates was “chief software architect.”

Yahoo epitomizes California cool; Microsoft is still trying to get over its competition-crushing past. But the culture clash may not be as big a stumbling block to the software giant’s rich buyout bid as some critics may think.

Yahoo Inc. is still mulling over Microsoft Corp.’s offer, worth about $42 billion based on Microsoft’s closing share price Friday. Even if Yahoo’s board and shareholders approve the takeover, U.S. and European antitrust regulators must still sign off.

Google Inc. stirred that pot Sunday with a blog post that called a combined company “troubling” from an antitrust standpoint; Microsoft followed with a statement of its own that the deal would actually improve competition.

Yahoo might appear more laid back, but the two are culturally closer than one might expect. For instance, while Google Inc. foots the bill for employees’ meals, Microsoft and Yahoo both make their work forces pay in the cafeteria. And while some associate afternoon soccer and cricket matches with Yahoo’s startup ethic, Microsoft’s campus is dotted with playing fields.

And their similarities extend far beyond the perks.

“Yahoo is not the sort of strapping startup it was 10 years ago. It’s a corporate organization with its own bureaucracies,” said Charlene Li, an analyst at Forrester Research.

Microsoft, for its part, has had to tone down its competitive behavior after a decade of antitrust problems. Though its Windows operating system is on more than 90 percent of the world’s computers, its perpetual lack of savvy online has also prompted it to experiment with Silicon Valley-style events, including inviting programmers to gather once a month in bean bag chairs to brainstorm and collaborate on cool Web projects.

Ali Diab, co-founder of a startup called Ripple TV, worked for both companies in the past. He said the talk of a culture clash is overblown, and noted similarities between Yahoo co-founders David Filo and Jerry Yang, and Microsoft founder and Chairman, Bill Gates, and its Chief Executive Steve Ballmer.

“David and Jerry, Bill and Steve — they’re quite technical, quite astute technologists, and I think the cultures deep down still reflect that at both companies,” he said. “Yahoo maybe a little more has a young, adolescent, college-like culture. But it’s a third the age of Microsoft.”

Diab, who reached the level of general manager when at Microsoft between 1998 and 2002, and vice president status at Yahoo between 2002 and 2006, said he didn’t sense animosity toward Yahoo while at Microsoft, or vice versa — just a natural sense of competition.

But in spite of the fact that Yahoo shares its Stanford roots with Google, both cultures harbor a burning desire to beat the search leader.

“It wasn’t, ‘Yeah, we’re just OK with being No. 2′” he said. “We were very much intent on being No. 1 in that market.”

The two companies are also not complete strangers to working together. Until Microsoft launched its own ad-serving technology in 2006, it used Overture, a search marketing system Yahoo eventually bought in 2003.

More recently, Yahoo and Microsoft teamed up to make it possible for their respective instant messaging users to chat regardless of which service they were signed on to.

Yahoo has also been one of the only companies to make use of some new features built into the year-old Windows Vista operating system. Yahoo’s latest instant messaging program was constructed with Microsoft’s answer to Adobe Systems Inc.’s popular Flash, a technology called Silverlight that has otherwise been slow to catch on.

All that doesn’t mean Yahoo will meekly agree to be swallowed up by Microsoft, even if the combination gets them part way to their goal of toppling Google.

Even as Microsoft revamps its e-mail and other consumer Internet products, and talks about weathering the industry’s shift toward computing done over the Web instead of on powerful desktop computers, it still doesn’t seem to “get” the Internet. Its online services business is a tangle of competing brands and a consistent money-loser. And while Google has launched Web-based word processing and spreadsheet programs, Microsoft has taken heat for moving slowly out of concern for its desktop software cash cow, Office.

“There’s a perception that the only reason MSN and Microsoft’s online services have been around as long as they have is because Microsoft has other successful, cash-rich businesses with which to fund them,” said Matt Rosoff, an analyst at the independent research group Directions on Microsoft. “Yahoo says, ‘We made it on our own, we don’t need people who have never had a financially successful (Web) business telling us how to run our business.'”

While tech-industry buyouts have a less-than-stellar track record — think Compaq Computer Corp.’s 1998 acquisition of Digital Equipment Corp., America Online’s 2001 buyout of Time-Warner Inc., or the rough start to Hewlett-Packard Co.’s 2002 takeover of Compaq — Microsoft may be able to shake that curse as well.

Industry analyst Rob Enderle said Microsoft-Yahoo is unlikely to suffer the culture clashes and integration problems that plagued others because Yahoo is clearly the weaker party. Some small turf battles may erupt, but the Yahoo contingent won’t have much leverage.

Microsoft faces plenty of problems, between antitrust concerns and the chance Google will step into the ring, if only to raise the price and sting Microsoft.

But once the deal goes through, Enderle said, “This is an easy merger.”

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