It is inevitable that Yahoo is going to lose its independence. It is just a question of timing and price.
Marc Andreessen on MFST's bid for Yahoo:
If Microsoft goes fully hostile on Yahoo
Posted: 28 Apr 2008 03:29 AM CDT
We have seen extensive press coverage of Microsoft's pursuit of Yahoo over the last few months, including notably excellent coverage from Silicon Alley Insider and the Wall Street Journal. However, I have not seen a detailed analysis of how a full hostile takeover might play out -- the kind of analysis that you would be receiving if you were a Microsoft or Yahoo board member.
So I asked a pair of expert corporate attorneys -- Michael Sullivan and Ed Deibert at Howard Rice Nemerovski Canady Falk and Rabkin in San Francisco -- to work up such an analysis. What follows is their take blended with my commentary. (Any factual errors have been caused by my edits to their work. This is complex stuff -- if you are a corporate attorney or investment banker and notice any errors, please email me: pmarcablog (at) gmail (dot) com.)
First, a wrapup of events to date:
Recall that Microsoft has offered to acquire Yahoo for 50% cash and 50% Microsoft stock. Specifically, a Yahoo shareholder would receive $15.50 in cash plus 0.9509 Microsoft shares for each Yahoo share. Given Microsoft's current trading price of $29.83 -- which is a little lower than when this all started -- the current offer value works out to $29.68 per Yahoo share. (You can track this day by day via Silicon Alley Insider's excellent bid calculator.)
Yahoo stock closed on Friday at $26.80 per share. The difference between that and the Microsoft offer price is $2.88, or about a 9.7% discount to the offer. That discount reflects the stock market's collective estimate of the odds of the deal not happening -- or, alternately, of Microsoft's stock falling further, or, alternately, of Microsoft lowering its offer.
At the time of the original offer -- January 31 -- Yahoo stock was trading at $19.18 per share. Microsoft's offer at that time represented a 62% premium. Since then, both the S&P 500 and NASDAQ indices are roughly flat, so it's reasonable to assume that if Microsoft pulls its offer now, Yahoo's stock will revert to approximately $19.18 per share -- perhaps a little higher if shareholders are more encouraged by Yahoo's standalone prospects now versus before, and perhaps a little lower if shareholders are less encouraged.
Three weeks ago, Microsoft set a deadline of last Saturday for the Yahoo board to accept its offer. Yahoo's board did not agree to the deal. In Microsoft's words: "If we have not concluded an agreement within the next three weeks, we will be compelled to take our case directly to your shareholders, including the initiation of a proxy contest to elect an alternative slate of directors for the Yahoo! board." Microsoft has also threatened to lower the offer price, but on the other hand Microsoft has also said in recent days that it might walk away from the deal. Microsoft also insists it will not raise its bid.
External factors are more or less the same as they were when the bid was originally made. There have been no alternate bids for Yahoo from any other companies in any form. Microsoft has signalled weakness in their own Internet business and lowered their 2008 Internet revenue estimates; this may reflect an oncoming recession, may be specific to Microsoft, or may represent a form of posturing in the negotiation.
The possible scenarios from here, in roughly decreasing order of probability, include:
-- Hostile Takeover: Microsoft moves forward with a full-fledged hostile takeover -- trying to replace Yahoo's board and/or taking its offer directly to Yahoo's shareholders.
-- Higher Offer: Microsoft raises its offer or otherwise modifies its offer terms to make them more attractive -- for example, Microsoft could shift to an all-cash offer -- in an attempt to make the deal happen without going fully hostile.
-- Walk Away: Microsoft drops its offer and walks away; Yahoo's stock drops to its pre-offer level of $19.18, give or take. Lots of moves and countermoves could follow: Microsoft could come back later with a lower or higher offer; Yahoo could cut a Google advertising deal to boost its revenue and margins and make itself harder to buy; Microsoft could take its $44 billion and go buy virtually every new Internet company of any consequence founded in the last 10 years; etc.
-- Yahoo Caves: Yahoo's board caves and accepts the current Microsoft offer.
-- White Knight: Another bidder enters and offers Yahoo a higher price.
Let's assume the Hostile Takeover scenario, which seems to me to be the most likely given Microsoft's strategy and explicit public statements. What happens then?
There are two primary hostile takeover tactics:
-- A tender offer, which we can equivalently call an exchange offer since the offer includes Microsoft stock that would be exchanged for Yahoo stock. This would be an offer by Microsoft to acquire Yahoo shares from existing Yahoo shareholders directly. Note that this hasn't happened yet; Microsoft's offer up until now has been made to Yahoo the company -- in a tender offer, the offer would be made directly to Yahoo's shareholders.
-- A proxy fight by Microsoft to take control of Yahoo's board of directors -- to put in place a new Yahoo board that would accept Microsoft's current offer.
These two tactics could be used alone or in tandem.
In the case of a tender offer: if shareholders owning more than 50% of Yahoo's shares agree to the offer, Microsoft gains control of Yahoo directly.
(Actually, Microsoft probably wouldn't need to own a full 50% of Yahoo's shares -- it could own, say, 40% and then have effective control, because only one-sixth of Yahoo's remaining shareholders would have to vote with Microsoft on any issue in order for Microsoft to exercise control.)
Yahoo's best defense against a tender offer is its poison pill. The poison pill works like this: if Microsoft acquires more than 15% of Yahoo without Yahoo board approval, the poison pill kicks in and issues a flood of new Yahoo stock into the market in such a way that Yahoo becomes much more difficult and expensive to buy. Poison pills have been used as defensive mechanisms by public companies against hostile takeovers for years, and the dilution they cause is so huge that no poison pill of this type has ever been triggered.
Rather than trigger the poison pill, Microsoft would most likely condition its tender offer on Yahoo's board cancelling its poison pill. If the Yahoo board refused to cancel the poison pill, Microsoft could sue in a Delaware court to force a cancellation of the pill. (Any and all litigation to force Yahoo to come to terms will be in Delaware, since that is where Yahoo is incorporated.)
Delaware courts give some deference to target boards in resisting hostile takeovers, especially in the early stages of a takeover fight, but in many cases the courts have been unwilling to allow targets to "just say no" in the face of a well-financed offer at a significant premium -- which is the situation Yahoo is facing. It's impossible to predict what a court will do, but Delaware courts are more likely to force a poison pill to be cancelled when a target board has had plenty of time to drum up alternatives to the hostile offer, and where the hostile offer is well-financed and represents a significant premium to the company. This gets even more likely if the bidder has raised its price during the process, which hasn't happened here -- yet.
In the case of a proxy fight, which Microsoft has overtly threatened: Microsoft would nominate an alternate slate of directors for election to the Yahoo board in place of the current directors. If Yahoo shareholders favor the Microsoft bid, they can vote for Microsoft's alternate directors, who -- if elected to Yahoo's board -- would approve the Microsoft bid.
A proxy fight may have special appeal for Microsoft for a couple of reasons.
First, it could work in one fell swoop.
Many public companies have a "staggered" board, where some directors are up for election or reelection each year, but the entire board is never up for reelection in a single year.
Yahoo, however, has its entire board standing for reelection each year.
In retrospect, this was not a good idea -- whoever set this up at Yahoo made a serious mistake. In a proxy fight with a staggered board, target management can lose a proxy fight and still control two-thirds of the board. In Yahoo's case, if Microsoft wins one proxy fight, it takes out the entire Yahoo board.
It would be practically impossible for Yahoo to change to a staggered board now -- in fact, trying to do so would immediately give Microsoft its opportunity to nominate its slate of directors.
Second, Yahoo can't block a proxy fight via a poison pill or any other mechanism. They can delay it -- a bit -- but they cannot block it.
Microsoft gets control of Yahoo if it puts up a slate of directors for election and they win at Yahoo's 2008 annual meeting. All that is needed for Microsoft's slate to win is to get more votes at the meeting than Yahoo's incumbent directors. Since not all Yahoo shareholders will bother to vote, Microsoft doesn't need a majority of all shares to win -- it just needs more votes.
As it turns out, Microsoft has leaked to the press the fact that it has already assembled a slate of directors who have agreed to run against Yahoo's board in the event Microsoft moves forward with a proxy fight. The Microsoft slate includes several former CEO's, COO's, and CFO's -- individuals certainly qualified to sit on a corporate board.
If Microsoft wins the proxy fight, then its acquisition of Yahoo is probably a foregone conclusion. Microsoft's slate of directors would be expected to vote to cancel the Yahoo poison pill, allowing Microsoft to make its tender offer for Yahoo's shares. However, the new Microsoft-installed board would still have to exercise its fiduciary duties and carefully assess whether the Microsoft offer is in the best interests of Yahoo shareholders -- if the new board acted rashly to rubber-stamp the Microsoft takeover, it could theoretically be sued by pro-Yahoo shareholders, although that lawsuit would be an uphill battle. Further, Yahoo's poison pill would throw some procedural hurdles Microsoft's way: the pill says that for a 180-day period following a successful hostile proxy fight, the new board can only cancel the pill if it follows certain procedures, including getting an independent financial advisor to opine that cancelling the pill is in the shareholder's best interests. All this would do is slow down Microsoft's takeover -- it would still happen.
Yahoo has taken other steps to respond to Microsoft's unwanted advances.
In February, Yahoo adopted a takeover-related compensation plan covering every full-time employee. The plan would issue large cash payments and 100% accelerated stock option vesting to Yahoo employees who are terminated "without cause" or who quit "for good reason" in the two years following a takeover. The devil is in the details -- if the definitions of "cause" and "good reason" are broad enough, the plan could give Yahoo's entire employee base easy access to 100% option acceleration and large severance cash payments after a takeover. The plan has the effect of making a takeover of Yahoo more expensive -- and Microsoft has responded by saying it might lower its offer price as a result.
Yahoo has also bought time by amending its bylaws to delay the deadline for making board nominations for this year's board election, and could buy additional time by delaying the date of its 2008 annual shareholder meeting.
Previously, Yahoo board nominations had to be made by March 14. While searching for an alternate bidder, Yahoo did not want to face a proxy fight starting in March, so it amended its bylaws to require board nominations to be made within a 10 day window after Yahoo announces the date for its 2008 annual shareholder meeting.
Yahoo has not yet announced the date for its 2008 annual meeting. However, under Delaware law, Yahoo has to have its annual meeting by July 12 -- the 13-month anniversary of its last annual meeting -- or Microsoft can sue to force a prompt annual meeting. Microsoft would almost certainly win that lawsuit, and the court would probably force a meeting within 60 to 90 days. So Yahoo can at least delay its annual meeting and therefore the board election process until July, and perhaps as late as October if it is willing to force Microsoft to sue to schedule a meeting.
So this may yet come to remind you of the Democratic presidential primary season -- it may last a while.
Other interesting questions:
How is Yahoo's board legally required to think about the Microsoft offer?
Delaware law requires a board to act in the best interests of the company's shareholders. Yahoo's board is not required to take Microsoft's offer, but a fully-financed offer at a 62% premium -- as this offer is -- puts a tremendous amount of pressure on Yahoo's board to take the offer, even if Microsoft doesn't increase the price. I.e. the Yahoo board is not refusing the current offer lightly.
If the Yahoo board continues to refuse Microsoft's offer without a better offer in hand, it could be dealing with shareholder lawsuits for years to come. These would be lawsuits where lawyers who specialize in such claims accuse the board of breaching its fiduciary duties and costing shareholders money as a result. Odds are Yahoo's directors would not be personally at risk, since Yahoo has various indemnity and insurance arrangements in place that protect directors from personal liability. But still, those lawsuits would be no fun.
What happens if another acquiror -- say News Corp. -- enters the bidding with a higher price?
Suppose another bidder, like News Corp., enters the fray and offers $32/share, versus the current $29.68 Microsoft bid. Yahoo's board would of course be free to take the higher bid from News Corp.
On the other hand, suppose Microsoft then raises its bid to $33/share, and then News Corp. holds its bid at $32/share. Could Yahoo's board still take News Corp.'s bid in preference to Microsoft's? In a word: no. When a board is presented with multiple offers, it can either take the highest objective offer or it can turn down all the offers. It cannot take an offer lower than the highest objective offer.
There is a caveat to this: a target board is allowed some leeway in interpreting an offer that consists of the bidder's stock, in whole or in part. So judging objective value can get complicated.
But the upshot is, even if Yahoo gins up another bidder, it still cannot accept an alternate bid if Microsoft's offering price is objectively the highest of the available offers.
Who are the Yahoo shareholders and how are they thinking about this?
Yahoo's shareholder ownership profile is the key to the ultimate outcome of all of this. If a majority of the shareholders want Yahoo to stay independent, it very well might be able to -- or, if not, not.
Insiders, including cofounders Jerry Yang and David Filo, own just over 10% of Yahoo's stock -- not enough to block Microsoft.
Institutional shareholders -- large professional money managers -- own about 72.4% of Yahoo's stock. These institutions, broadly speaking, fall into two categories: normal investors, and arbitrageurs.
Normal investors may want to back Yahoo management, but yet may still be forced to vote in favor of the Microsoft deal since they may be unwilling or unable to stomach the likely fall in Yahoo's stock price if the deal doesn't happen.
Arbitrageurs, on the other hand, are only in the stock to make money on the spread between Yahoo's current stock price and the ultimate offering price of a consummated deal. These are the people who bought Yahoo stock on the day Microsoft's offer was announced, when Yahoo's stock jumped nearly $10 in a single trading session. They will always support a transaction, by definition -- the last thing they want is to be long-term holders of anyone's stock.
It's not clear what percentage of Yahoo's institutional ownership consists of arbitrageurs vs normal investors.
Finally, individual shareholders own the remaining approximately 17% of Yahoo's shares. What they do is always anybody's guess.
In practice, there is a group of about seven or eight large institutional shareholders who will ultimately decide Yahoo's fate.
Would a dual-class share structure have been a good idea for Yahoo?
Yes.
A dual-class share structure is when a company's founding managers or investors own a different kind of stock that gives them voting control of the company even when they don't own a majority of the total shares.
Dual-class share structures have been common for decades in the media industry -- they are the reason the New York Times is still controlled by the Sulzberger family, even as the value of its business plummets towards zero. But they have not been common in the technology industry, where they have been viewed as hostile to normal investors.
However, I think Google has changed all that -- Google has a dual-class share structure that gives Larry Page, Sergey Brin, and Eric Schmidt de facto total control over the company, and investors certainly haven't avoided Google's stock as a result.
Yahoo does not have a dual-class share structure, and it's too late to put one into place now.
If Yahoo did have a dual-class share structure, Yahoo's cofounders would have been much better situated to block Microsoft from attempting a takeover.
You can bet that this is being noticed by the founders of every technology company that might go public from here on out.
What are we learning about hostile takeovers in the technology industry?
We are learning that hostile takeovers have arrived in our industry. This is the second major hostile takeover so far -- the other was Oracle's takeover of Peoplesoft -- but there will be more.
This is significant because historically hostile takeovers practically never happened in technology. Potential hostile acquirors assumed that hostile takeovers wouldn't work because the target company's employees would bail and the target company's business would collapse.
It turns out that as technology companies become larger and more mature, acquirors are becoming increasingly convinced that neither of these assumptions hold. Perhaps employees of large tech companies aren't that bonded to current management, and perhaps many of them would actually prefer to work for a larger, more dominant combined company. And maybe as a consequence, the target's business would do just fine in the wake of a hostile takeover -- in fact, maybe it would do better, due to advantages of combined size and scale.
My bet is that hostile takeovers, particularly of larger and more mature companies, are going to become increasingly common in our industry.
The excitement may be just beginning. |
