Friday, May 9, 2008

MSFT YHOO - Deal or No Deal?

If there is no hostile activity by May 15th, its more likely that YHOO will sign up a deal with GOOG, because Yang won't have to worry about his position and board seat anymore.

The conflicting signals coming from MSFT execs indicates that they are in a state of disarray and don't have any well-defined cogent strategy. This means that they are unlikely to come back to the negotiating table soon.

Rav said:
May. 09, 2:56 AM

I doubt that MSFT intentionally leaked the town hall meeting, with exclusive rights to SAI. My guess is that some MSFT employee, let's call him FSAI (friend of SAI) attending the meeting was relaying the information to SAI. When MSFT found out, they released the full transcript, so that there is no mis-interpretation in media. I think that was primarily intended for internal consumption, addressing the concerns of the MSFT rank and file, who have their substantial assets in MSFT.

I agree that at that point Ballmer was probably considering $33-36. The real issue at that point was that Yang wasn't interested and was looking for any kind of way out, even if it meant "burning furniture". Ballmer was ready for all this - justify spending so much money on acquisition, take a hit on stock, deal with the regulatory purgatory - if Yang had indicated at least once that he would agree to a friendly deal. He realized that a hostile (i.e. unfriendly) deal is simply not worth it at any price in the ~$30+ range with all the pain that it would bring and destroy value at YHOO. His letter mentions this in gory detail.

As you mentioned, in early january all tech stocks were trading well and MSFT was in mid-thirties. They had an excellent quarter, stock had good momentum and Vista still wasn't declared a failure by then. On the other hand, YHOO had a crappy quarter. So it was a perfect time to make a bid. The time to court big YHOO shareholders and go hostile was right then but they wasted precious time. Part of the problem is that they are not experienced in making these kind of big deals. Look at their failures in deal-making (GOOG in ~2003, Youtube, Doubleclick recently). I wouldn't call facebook investment a success either. You either need to be like Larry Elison or pay a high price and close the deal aggressively like Murdoch or GOOG guys. I think MSFT was trying to be penny wise and pound foolish.

The critical event in all this was GOOG closing on DCLK. I don't see anybody mentioning that. Also, a so-so quarter from MSFT didn't help matters. If MSFT had gone hostile with YHOO early on, they could have prevailed. With DCLK acquisition under the regulatory scanner, I'm sure GOOG wouldn't have dared to get cozy with YHOO and provide an escape hatch to Yang. Now they sound emboldened based on their comments today.

I think MSFT walking was really good for walksters and MSFT stock holders. I was expecting MSFT stock to pop to ~$31 and slowly drift to ~$29 over time. But damn, the stock market is smart and fast.... If MSFT had closed on the deal, it would have been lot worse for MSFT stock-holders regardless of the price. This is the reason that MSFT didn't specify the cash/stock split in their new $33 offer, as it would set expectations for potential offer in future and negatively affect stock. This was also the reason that Yang wanted some guarantees / valuation collar. Remember that the original $31 offer drifted down to $29 in couple of months. Who knows what happens to a $33 offer over a year, when the merger is approved.

At that point, YHOO was probably looking for ~$37 offer, with 75% in cash, rest in stock, with some valuation collar and substantial breakup fees if merger doesn't complete for any reason. I think they would accept $34-35 at this point, with those kind of terms. However MSFT can't afford to pay that without substantial hit to its stock. So they would hope that their MOJO returns and YHOO's MOJO goes down, before making another offer. In fact almost everyone, with few exceptions, was expecting that to happen. I think MSFT walked with that expectation as well. But alas, the market has its own ways...

I think may 15th is really critical date if MSFT wants to make a move. They probably don't realize this. After that date, GOOG and Yang would structure the deal in a way that GOOG benefits most and YHOO gets better financially. As per the terms of that deal, it wouldn't make sense for MSFT to acquire YHOO again in future. YHOO stock will trade around $30, and big shareholders won't bitch anymore. MSFT will continue its slow bleed to irrelevancy unless it can reinvent itself like IBM did during the last paradigm change.

Rav said:
GOOG and YHOO will wait till may 15th deadline for YHOO's nomination of new directors. If this date passes without any hostile activity, then they'll complete the ad outsourcing deal after carefully considering regulatory issues, before the YHOO shareholders meeting. If MSFT or activist investors in YHOO, try to unseat Yang by nominating their own slate of directors, then Yang will sign with GOOG even sooner. GOOG will try everything that it can to dissuade YHOO from merging with MSFT. It may also increase the cost of merger with MSFT, by offering to improve YHOO's cash-flow. Today's comments by GOOG management should be seen in this context.

MSFT plan to walk from the deal has backfired based on the stock market action in MSFT and YHOO stock. Also, if they try to do something hostile or make overtures to YHOO, that will be a tremendous loss of face for them, so I don't expect them to do this by may 15th. Any deal between MSFT and YHOO with substantial cash payment in the range $33-35 will lead to a further drop of at least 5% in MSFT stock. So its unlikely that MSFT will try to come back to the table unless and until YHOO stock goes to ~$20 range, which is very unlikely in next couple of weeks, based on the action so far. Till that time they'll pretend to be not interested in YHOO and occasionally send signals of interest to keep the flame burning.

Rav said:
May. 08, 9:45 AM
Great Idea!! If MSFT pays $15-20B for a fad (Mr. Ballmer's words, not mine), then MSFT will hasten its demise. It would be even better if they buy both YHOO and facebook in all cash deals. All that cash would be good in the market and can you guess where all of that would end up?

Rav said:
May. 08, 2:07 PM
I still think GOOG and YHOO deal is quite likely. I think Yang and GOOG are "saving the bullets" now, in case they need them before the may 15th deadline for nominating new YHOO board members.

MSFT walking from the deal hasn't affected the YHOO stock much, so there is no urgency to announce the deal with GOOG.

If the big YHOO investors or MSFT try to nominate new board members for YHOO, then there will be an urgency for GOOG and YHOO to announce something. If that doesn't happen my May 15th, then they would have even more time to consider this deal and walk through the regulatory hoops. So far MSFT hasn't expressed any interest in a hostile deal and the big investors in YHOO are still doing fine in terms of their YHOO stock value, so they are less likely to do something hostile.

Market is giving more credit to Yang instead of Ballmer the way this deal got negotiated. If Yang had accepted the so called $33/share deal, which wasn't well defined, YHOO would have at most traded at $29, due to all the uncertainties and depending on the stock/cash component and valuation collar in the deal. MSFT would have traded down even more, reducing the deal value.

Rav said:
May. 07, 9:47 AM
The street is looking at the potential value of this kind of arrangement. YHOO doesn't need to realize this value all in one shot. It can be incremental. If the max revenue improvement is about $1B, it could potentially be worth about $6 per YHOO share. The increased cash flow to YHOO can be deployed in new projects that can lead to further growth. The arrangement can begin as a partial outsourcing and then depending on the outcome of that and any anti-trust issues, it could lead to further outsourcing in future.

Rav said:
May. 07, 10:13 AM
Henry, based on the historical trends, no matter what YHOO does or doesn't do, its query share is going to decline over time due to natural monopoly in search and network effects. So the choice is either leave the money on the table by poor monetization or milk the current search share and deploy the additional income in the next big thing.

Rav said:
May. 06, 2:56 PM
Guys, watch this equation: (9.31*MSFT-0.313*GOOG). That's the delta between MSFT and GOOG in B$. Its about 90B$ today but going down fast.

Based on the market action in last couple of weeks, it seems like MSFT-YHOO deal or no-deal won't have any material impact on GOOG. This delta will keep going down. The rate would be faster if MSFT acquires YHOO and slower if MSFT stays on the sidelines.

In case of walking from the deal if MSFT doesn't manage to rally, then imagine what could happen to MSFT stock if it actually ends up buying YHOO for ~$33+. I guess its the walksters worst nightmare.

When analyzing Yang's actions, nobody is talking about the nuisance value of YHOO to MSFT. I guess $33 was a fair strategic value for MSFT, but YHOO wanted another $4 of ransom (i.e. nuisance value), in order to not sign a deal with GOOG. I think that was fair, because YHOO not partnering with GOOG is definitely worth another 5B$ for MSFT.

The stock market is suggesting that MSFT is between rock and a hard place, and not YHOO as most commentators expected. YHOO is up about 37% from the 19.08$ price prior to deal announcement and MSFT is actually down.

Rav said:
May. 06, 7:43 PM
The next act of this drama is going to play out by May 15th. That is the date by which new board members for YHOO could be nominated. I think Yang, is most likely sitting on the GOOG offer to use as a backup in case either MSFT or others try something hostile before May 15th. So I don't think the YHOO-GOOG deal would get announced till then, unless YHOO stock starts tanking.

Let's face it guys. MSFT walking out has had a very minimal negative impact on YHOO. On the contrary YHOO is up about 35% from its pre-deal price of ~ $19, within is a 3-month period. That is a great return.

Even if Yang had accepted the $33 offer from MSFT and if that offer was half-stock and half-cash, YHOO would probably still be trading at 28-29, due to deal completion and regulation uncertainty. The merger would still take about a year to close. (Remember Doubleclick) MSFT would probably be trading down making the offer lower.

I see only two possible outcomes here - MSFT pays about $35 with significant cash component or YHOO signs deal with GOOG. First event would be mild positive for GOOG and second would be bigger positive. The deal below $35 with MSFT has some uncertainty, but the deal with GOOG should add about $6 worth of value to YHOO based on some estimates.

If none of those happen, then both MSFT and YHOO would become weaker players and GOOG would still benefit. I don't see a scenerio where GOOG loses. Do you?

Rav said:
May. 05, 9:23 AM
I don't understand the premise for shareholder lawsuits. Based on pre-market action, YHOO shares would end up much higher than the $19 price (on 1/31) prior to the merger announcement. Also, stock holders had a lot of time until friday to take their profits. Only the greedy ones, who were still betting on the deal closing are left holding the bag. Since the stock was trading at ~$28 on friday and not at $33 which MSFT was reportedly ready to offer, everyone was aware that there is some uncertainty that the deal may not close.

Only claim shareholders could potentially make is that YHOO BOD didn't satisfy its fiduciary responsibility. However that would be a stretch because YHOO did hire investment bankers and based on the CNBC report were quite engaged in the negotiation.

Rav said:
May. 05, 10:48 AM
Here is another way of looking at the situation today, which most people seem to have missed.

MSFT is the real loser here. Today YHOO is 25% higher than what it was on 31-Jan-08, prior to MSFT deal announcement. MSFT is down 8% from 31-Jan-08 closing price. GOOG is up about 5% since that date.

If YHOO announces a deal with GOOG, then it would look even worse for MSFT. What has MSFT achieved here, other than highlighting its precarious position in the online world compared to GOOG and getting GOOG and YHOO closer to a deal?

YHOO closing prices:
1-Feb-08 28.38
31-Jan-08 19.18

MSFT closing prices:
1-Feb-08 30.45
31-Jan-08 32.6

GOOG closing prices:
1-Feb-08 515.9
31-Jan-08 564.3

Rav said:
May. 03, 8:53 PM
Guys, those are my comments from last weeks thread. I still believe this is how it will play out in the market.

Rav said:
Apr. 26, 2:31 PM
I think MSFT goal is to acquire YHOO at <= $35 in a friendly deal. Its simply not worth that much if they have to go hostile. In fact it may not be even worth a few bucks lower, if they have to go hostile, due to all the negatives that come out of the hostile deal like uncertainty, employee churn, distraction etc. Its possible that Yahoo management may adopt a scorched earth policy if they see a hostile deal winning.

As joeblow explained above a +/- 10% is not a big deal for MSFT considering their financial condition and how desperate they are for YHOO. They have all along been trying to get a friendly deal, so I doubt they would go hostile at this point. Also I believe that Yang won't accept anything below $40 for a friendly deal, which MSFT can't afford due to the negative effect on its stock. I think the most likely outcome at the end of this weekend, would be that MSFT would pretend to walk, just to see the effect on YHOO stock. After a few weeks of this pretension, if YHOO stock goes down significantly, they will come back with a hostile $31 offer. If YHOO stock remains unchanged or goes up (I know, very few people believe in this scenerio, but its likely in my opinion, depending on market conditions), then they will complete a friendly deal with Yang in the $35 - $40 range. They would have a good justification and a stronger stock for this at that point.

Assuming this is how it plays out and MSFT walks on monday, the way to benefit from this is with a hedged options play is as follows:
1. Its stock will go up short term. Once it settles, buy Jan 09 puts on MSFT.
2. YHOO stock will react and fall down a few bucks . Once it settles, buy Jan 09 calls on YHOO.
3. Also buy GOOG Jan 09 calls.

After a few months, its likely that MSFT would close on Yahoo. In that case both (1) and (2) will make money. If that doesn't happen, then (1) and (3) will make money and cover any losses on (2). If YHOO makes a deal with GOOG to outsource its search, then all of them (1), (2) and (3) will make money.

In the worst case, if nasdaq crashes, (1) will make money probably not enough to cover losses from (2) and (3), and if nasdaq rallies big time, (2) and (3) will make enough to cover any losses from (1). At this point nasdaq crashing seems like a low probability event based on valuations

Rav said:
May. 03, 9:06 PM
Another comment that I have is that, Yang and Yahoo BOD have now boxed themselves in a corner, where the only option they have of preventing a catastrophic drop in value and share price is announcing a search outsourcing deal with GOOG ASAP. Since Yang was so steadfast in negotiating the deal with MSFT, I believe he must already have a broad agreement with GOOG in his pocket. I would not be surprised if YHOO and GOOG are negotiating the details and announce something before Mr. Market opens on monday.

If this plays out as I expect, any guesses on what the GOOG open would be on monday?

Victor - any ideas?

disclaimer: long on GOOG, no positions on MSFT/YHOO

Rav said:
May. 02, 1:45 AM
I’m sick of all those comments which assume that YHOO will fall down hard, if MSFT walks away. If MSFT walks they will be the only losers. YHOO will immediately announce a deal with GOOG and regain whatever value it loses. It is really the ace of trumps in its hand.

I’m sure the game theorists at GOOG have analyzed all possible scenerios and will structure the YHOO-GOOG deal in such a way that any anti-trust concerns would be addressed and dealt with in advance.

Based on GOOG’s success in completing DCLK acquisition and opening up C-block wireless by bidding, I have confidence that GOOG will come out a big winner from this imbroglio.

If MSFT doesn’t bid to win a friendly YHOO deal, its internet dreams are toast and if it does bid to win ($37+), then its stock will bleed. A short-term bleed might be acceptable by shareholders, if it leads to long-term growth. I would like to add that in internet space, "time is of essence". Its not a good place to nickel and dime. MSFT should learn from GOOG's DCLK bid and be ready to pay big bucks, if they really want the deal to close.

People who suggest that they go hostile are either wall-street types who don’t understand how innovation works in silicon valley or are short-term YHOO buyers hoping to make a quick buck. Remember that MSFT is bidding for the hearts, minds and brains of YHOO, not just the physical assets or the shell of the company.

Another possibility that I haven’t seen mentioned anywhere, in case of a hostile MSFT bid is that the current YHOO management may sell off its Asian assets and sell the remaining assets individually at premium prices, without any anti-trust issues. This would probably be a last resort, and may happen only if the current YHOO BOD is on the verge of losing shareholder vote. This is another thing for MSFT to consider if they plan on going hostile.

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