Microsoft-Yahoo Deal Appears Likely
Wednesday February 20, 6:28 pm ET
Pete Barlas
Analysts say Microsoft will end up with a lot to "Yahoo!" about, but it might come at a greater cost and effort than the software giant had counted on.
Microsoft (NasdaqGS:MSFT - News) can use a proxy fight to replace Yahoo (NasdaqGS:YHOO - News) board members in an effort to push through its previously rejected bid to acquire the company, but analysts expect the two sides will eventually reach an agreement much sooner -- and on far friendlier terms.
"Microsoft appears to want this company very badly," said Mike Egan, senior partner specializing in mergers and acquisitions for King & Spalding, a law firm. "They will probably end up putting enough pressure on their board and raise their bid enough that they will end up making the transaction."
Proxy Threat
Microsoft's strategy shows the company is willing to do nearly anything to drive Yahoo to the negotiating table, he says.
Reports of Microsoft's intention to launch a proxy battle surfaced Tuesday, a little more than a week after Yahoo rejected the company's $44.6 billion acquisition bid. Microsoft's offer represented a 62% premium above Yahoo's share price on Feb. 1, when it announced the proposal.
The offer is now worth about $40 billion, based on Microsoft's current share price.
On Monday Microsoft Chairman Bill Gates told a reporter the company has no plans to raise its bid.
But it's more likely that Microsoft's threat of a proxy battle and Yahoo's rejection of Microsoft's bid last week are merely corporate saber rattling, says Emery Trahan, professor of finance and insurance for Northeastern University.
"It's unlikely they would go to a proxy contest," he said. "Microsoft obviously would like to get Yahoo for the best price they can, and Yahoo may be posturing to get a higher price. So it's a situation of who blinks first."
Microsoft wants to acquire Yahoo to better compete with rival Google (NasdaqGS:GOOG - News), the Web's No. 1 Web search service. Google handles more than 50% of the Web searches in the U.S. It also leads in paid search, the fastest growing segment of the multibillion online ad market.
Microsoft and Yahoo operate competing search services that rank far behind Google.
Microsoft is also counting on Yahoo to help boost its online display ad business, the second fastest growing segment of the online ad market behind paid search.
Last year, Microsoft reported a loss of $745 million from its online operations on sales of $2.47 billion. Over the same period, Google's earnings totalled $4.2 billion on sales of $16.5 billion. Yahoo reported earnings of $660 million on sales of $6.96 billion.
Analysts say proxy fights are rare. Microsoft would have to notify Yahoo about three months ahead of its annual shareholder meeting that it intends to present a new group of candidates to serve as the new board of directors. All of Yahoo's current board members are up for re-election.
Yahoo's last annual shareholder meeting occurred in June. The company won't say when it will hold its next meeting.
Analysts say Microsoft is using the proxy fight to circumvent a poison pill, a strategy used by companies to prevent unwanted takeovers by flooding the market with additional shares to dilute the holdings of hostile acquirers.
Yahoo's poison-pill plan takes effect if an outsider buys 15% or more of Yahoo stock in a transaction not pre-approved by the company's board of directors.
So far, most Yahoo shareholders seem to welcome a merger with Microsoft. What's more, a Microsoft-backed board would almost certainly negate the poison pill, which makes it useless for Yahoo to resist, says Morton Pierce, chair of the mergers and acquisitions group for Dewey & LeBoeuf, a law firm.
"This is why the threat of the proxy is usually sufficient to get people to negotiate, because there is no reason (for Microsoft) to go through this process and lose," he said.
Microsoft could also have another motivation for launching a proxy battle. Last week Yahoo reportedly held talks with News Corp. (NYSE:NWS - News) about selling a 20% stake in Yahoo in exchange for social networking king MySpace.com and other News Corp.-owned properties.
Pushing For More
Yahoo is likely using the News Corp. talks to push Microsoft into making a higher bid, says James Owers, professor of corporate finance for the Robinson College of Business at Georgia State University.
"They are either trying to get Microsoft to up the bid or have Yahoo shareholders see that they talked to News Corp. but they got a higher offer (from Microsoft)," he said.
It would be unusual for a company in Microsoft's position not to come back to the table with a sweeter offer, Egan says.
"It's typical that when a company first initiates a hostile action like this that they don't put their last dollar on the table; they hold back some value they are willing to offer up later," he said.
Reports that Yahoo adopted more generous severance packages for employees to protect them in the event of layoffs seem to suggest that a deal is in the works, says Owers.
"That is a classic signal that Yahoo believes it's going to go through," he said.
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