Covering the digital giants, by Jon Fortt

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February 7, 2008, 3:00 am

How Yahoo might get away

Microsoft’s $40 billion bid would be hard to refuse, but there are escape routes.

Yahoo co-founder and CEO Jerry Yang spurned Microsoft’s advances more than a year ago, and insiders say he’s now exploring ways to evade the hostile bid. Courtesy of Yahoo.

Yahoo stock spiked after Microsoft’s bid, reclaiming levels it last saw in November when investors were more optimistic.

Microsoft stock has slipped to September levels as investors express concern about its hostile bid of more than $40 billion for Yahoo.

Since Microsoft bid more than $40 billion for Yahoo last week, the Internet pioneer’s future has been very much up in the air. Many observers seem to think Microsoft will win its prize, given the truckload of cash it’s offering — but others aren’t so sure. In fact, there are ways that Yahoo might get away.

If Yahoo (YHOO) co-founder and CEO Jerry Yang is to wiggle his company free of Microsoft’s (MSFT) clutches, he’ll have to:

a) Find a white knight willing to top Microsoft’s bid.

b) Outsource search to Google; or

c) Break off bits of the company to boost the stock price.

None of these options looks like a strong possibility. Here’s why.

For those who like the idea of Yahoo controlling its destiny, there’s a certain appeal to the white knight scenario — at least Yahoo gets to pick its suitor rather than submit to a shotgun wedding. But the problem here is that Yahoo’s carries an expensive dowry, and the companies that can afford it probably won’t pay.

Traditional media companies like Time Warner (TWX) or Disney (DIS) would be a natural fit, but they can’t afford Yahoo. Many of them already have plenty of debt, a paucity of cash, and the legacy of the AOL/Time Warner deal to remind them (and investors) how badly these old media-new media deals can go. The one company that might have had the credibility to make such a bid is News Corp. (NWS), but CEO Rupert Murdoch has already ruled that out.

Then there are the tech companies like Hewlett-Packard (HPQ), Cisco (CSCO) and Apple (AAPL), which, like Microsoft, could possibly afford to acquire Yahoo with a combination of cash, debt and stock. But why would they? Buying Yahoo means taking on Google, and that’s something most big Silicon Valley companies would just as soon avoid. Just look at Apple — Google’s maps are among the most popular pieces of software on the iPhone, and Steve Jobs has said his engineers love working with Google. Why mess with a good thing?

And what about the idea that a sovereign wealth fund could get into the mix? Overseas investors have been on a spending spree lately, taking advantage of the plummeting dollar. Last May, China’s fund put $3 billion into Blackstone Group (BX); in November Abu Dhabi put $622 million into Advanced Micro Devices (AMD) and $7.5 billion into Citigroup (C). But those numbers are still far short of Microsoft’s $40 billion offer.

Inking a search deal with Google would be another way for Yahoo to potentially evade Microsoft. “We believe the probability of this (25%) is greater than financial markets realize,” Citigroup analyst Mark Mahaney wrote in a research note. He said the move could boost Yahoo’s cash flow by as much as 25 percent — a move that would certainly cheer shareholders.

Strategically, though, such a deal with Google could marginalize Yahoo, making it more of a media company than a technology company. Yahoo management has worked to avoid that fate over the past few years, making clear that their goal was to take on Google in search and even spread its own search technology to other sites such as WebMD (WBMD). Outsourcing search ads would also hurt Yahoo’s display ad business, which competes directly with Google. Without a search ad business, Yahoo could no longer claim to be a one-stop shop for online advertising.

Which is a reason why it might not make sense for Yahoo to break itself up and sell off some of the pieces, another strategy some have suggested to keep the company independent. Unlike Microsoft, which is a collection of mostly separate businesses that make Windows, Office, Xbox and MSN, Yahoo has one core business: selling ads on Yahoo search and content pages. That doesn’t leave much room for spinoffs.

“I can’t see them breaking out their assets — I don’t think that would make any sense,” said John Byrne, analyst with Technology Business Research. “One breakup scenario would be to have them sell off their content sites — news, sports, e-mail, IM etc. and keep their ad platform. But in order to have a workable ad platform, you need to have content sites on which to place ads.” Of course, that would also mean abandoning the freewheeling online culture that has long defined the company.

Some pieces would be easier to break off. Yahoo Japan, in which Yahoo has a 33 percent stake, is up nearly 10 percent on news of Microsoft’s takeover bid — a Sanford Bernstein analyst says selling that and its stake in Chinese search engine Alibaba could net nearly $18 billion. But beyond that, it’s tough to see what Yahoo could auction off that would unlock shareholder value.

In the end, Yahoo’s most effective evasive maneuver might be to drag the process out as long as possible. Why? Microsoft’s stock has dropped more than 10 percent since it announced its hostile bid — a development that both decreases the value of its offer and irks any Microsoft shareholders who are skeptical of the deal. That’s why you can be sure that Microsoft won’t give Yahoo board members long to ponder their escape options before the software giant moves to take the deal directly to Yahoo shareholders.

Michal Lev-Ram contributed to this report

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Filed under AMD, Advertising, Analysis, Apple, Cisco, Financials, Google, Microsoft, News, Online, Yahoo

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Yahoo is screwed no matter what they do. Most people would just cut and run leaving their users high-and-dry while Microsoft finds its feet.

The best option is reduce the company size substantially, buy back their stock, and go private.

Posted By Sam, Salt Lake City, UT : March 1, 2008 12:17 pm

just go along with microsoft for time being & later go with some other prosses which would gain more income from the cash provided by microsoft

Posted By sridhar Bangalore India : February 27, 2008 6:31 am

There has NOT been much of an innovation in search in past decade. What search engines have tried to do is to fight off the massive amount of content that is flowing to internet by making sure that they can still dig and find what users are looking for stacked under rubble of garbage. Yahoo needs to be creative and break off from the look and feel that they have in their search and be more creative. Basically Change the search name from Yahoo search to something else so people can identify the new entity with a name that is focused on search (and keep the yahoo name for their other mediums such as news, email, map, entertainment and etc). The previous CEO of yahoo made a bad move by taking a software company and making a media company out of it. Yahoo was a company with advance engineering, technology and massive infrastructure of software and hardware embedded into its DNA. All the sudden Yahoo became a media play delivering finance, sports, news, … rather than focusing on using technology to aggregate, arrange, filter and deliver content based on technology NOT editors and writers and producers. NOW yahoo got to make the break, change its look and feel, change the search name to something different and create a disruptive platform and break away from a typical search look and feel of Google, Microsoft pack. Yahoo still commands a 25% market share and they can make the turnaround and stay away from Microsoft and Google.

Posted By Ali Ghafouri, Oakland – California : February 8, 2008 3:17 am

Mhoo or MicroHoo is a typical MS reaction to waking up late and trying to catch up on a major market trend (read Internet). MS (X) + Yahoo (Y) < X+Y, when combined, they will be smaller than their independent sizes. MS should instead invest in a separate division that shapes the course of the Internet after 2 years, than take on old baggage being brought in by Yahoo. What made MS successful was its ability to invest in the future technology backed with awesome strategic deals and money power that turned its second mover disadvantage to a real large advantage. Buying Yahoo wont solve its recent Google fixation. Maybe instead MS can help move the anti-trust provisions (that it so well understands) and force Google to send 8% (dont ask me why 8%) of all Google visitions / search ad users automatically to MSN to prevent monopoly provisions to be activated

Yahoo should make up its mind whether it wants to be a technology player with interests in media, or vice versa, and spin off units that dont make strategic sense (but still make business sense) into separate companies. Perhaps it can put in a non-compete clause for certain sections, or tie up with those separate companies for say 2 years for providing content / advertising to its network after which they are free to live their own lives.

What about Google ? Google is focussed on the customers and doing what it does best – innovate, keep it simple, and let users vote (aka click) for it. Will Google turn into a gigantic monster ? Not yet. Will Google still exist in 2020 ? Now, lets get back to Nostradamus’s last book shall we

Posted By Lalit Saraswat, Goa, India : February 7, 2008 10:57 pm

I think Yahoo should sell and make the most of it. In the Microsoft and Google world they are a pigmy and falling behind quickly. They could hope to combine with Microsoft machine and at least be there – Microsft also needs Yahoo to compete and will ensure key people stay on. I think yahoo should bargain for the best price and just sell quikly.

Posted By Sanjay T, Cary, NC : February 7, 2008 9:50 pm

There is an extreme danger [anthropologically speaking] of consolidating the search algorithm of Yahoo into Google. Loss of diversity in search will exacerbate the current process of “dumbing down” people in “the age of videography”. Since we don’t all want to be vidiots see:
http://vidiots.us/2008/01/google-fails-videography-lab-test.html

Posted By Bob Kiger, Oceanside, CA : February 7, 2008 12:02 pm

Yahoo can consider partnering with global mobile device market leader ( probably Nokia )to synergise in converging mobile & Internet space. This is what Google is trying to achieve as well with its own mobile strategy. This helps in speeding up the technologies convergence that is moving too slow in recent years. To be able to have a breakthrough in formulate new stratgies and expand markets & services and not just finding a escape route from the hostile takeover.
Even if there is an escape, the market would ask , what’s next from Yahoo?

Posted By peter,singapore : February 7, 2008 10:55 am

Given that MSFT has no history of being able to manage online content, an acquisition of YHOO would mean YHOO’s demise and would be very unfortunate for loyal Yahoo users, like myself. Yang is right to look to alternatives. he should swallow his pride and work WITH Google, instead of trying to work against them.

“I think Microsoft should take their offer directly to the shareholders and let them decide what they should do”

The shareholders can vote with their feet. Short term investors should have sold last Friday. Longer term investors can vote every year, at the annual meeting.

Posted By Tom Barta Durham,NC : February 7, 2008 9:13 am

I think Microsoft should take their offer directly to the shareholders and let them decide what they should do, Mr. Yang might just prolong this offer as long as he can knowing that it helps to keep his stock value up, and all the while he is searching for another suitor.

Posted By thenoseknows, Houston, Texas : February 7, 2008 8:25 am

about the given options:

a) very hard to find one that pay more

b) a suicide that falls the Yahoo value

c) needs time, then, it’s too late now

however, WHY should Apple, HP, Murdoch, Disney, Time Warner, etc. be BETTER than Microsoft?

—————————–
Gaetano Marano – Italy
http://www.ghostNASA.com/
http://www.NewSpaceAgency.com/

Posted By Gaetano Marano – Italy : February 7, 2008 5:18 am

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About This Author

A senior writer for Fortune, Jon Fortt focuses on technology and innovation in Silicon Valley - a subject he's been reporting on since his days as a rookie reporter for the Lexington (Ky.) Herald-Leader. Before joining Fortune in 2007, Jon had reporting and editing stints at Business 2.0 magazine, and the San Jose (Calif.) Mercury News, Silicon Valley's hometown newspaper.