To read Microhoo - Round 2 the follow up to this article click here
The Offer
Microsoft has offered to buyout Yahoo for 44.6 Billion. The Yahoo shareholders can choose either cash or 0.9509 shares of Microsoft, a 62% premium to the closing price of Yahoo of 19.18 on Jan 31 2008.

Why Microsoft wants yahoo

  • Microsoft gets a world class internet franchise. Yahoo is the biggest portal on the web and the site with the highest number of views, about 500 million per month.
  • 16.7 Billion in cash and assets. Yahoo has a lot of hidden assets that no one considers in their valuation like Yahoo Japan, Alibaba, Gmarket. A recent motley fool article by Rick Aristotle Munarriz calculated the value of these assets at 14.3 Billion + cash equivalents of 2.4 Billion.
  • 1.33 Billion in recent acquisitions In the last year it bought Zimbra for 350 Million, Blue Lithium for 300 Million, Right Media for 680 Million.
  • Yahoo also owns del.icio.us, Flickr, Konfabulator, Overture aka Yahoo Search Marketing (Yahoo paid 1.6 Billion in 2003), Hotjobs. Pulling a number out of my hat I’d say these are worth at least 2 Billion.

The price Microsoft is paying is not as exorbitant as it seems. The total value of cash and assets Microsoft receives is about 20 Billion. So in effect Microsoft is buying out Yahoo’s core portal+mail+search+messenger business for 24.6 Billion.

Microsoft’s MSN and Yahoo have a lot of businesses in common. Their portals provide news, finance, entertainment, search and maps. Microsoft and Yahoo also overlap on webmail and messenger services. A merger will bring about significant savings by removing redundant infrastructure and operating costs. The combined entity would have enough market share so that it can compete with Google. The press release says that Microsoft expects to generate 1 Billion in synergies for the combined entity. Currently Yahoo’s profit is 660 Million, MSN’s loss is about 250 Million, and synergies are 1 Billion. Microsoft can earn 1.4 Billion per year on an investment of 24.6 Billion, the merged unit has an effective P/E of 17.5.

How it affects Yahoo
Yahoo is steadily losing market share not only to Google but also to Microsoft. It would be great if Yahoo could merge with Google. Yahoo would provide the content and Google would provide the technology for search and advertising. Unfortunately since Google has a 56% share of the search marketplace the chance that a merger will be approved is zero. It has been mentioned that Yahoo could outsource the search and advertising to Google for an instant increase in earnings but that would mean giving up of the search and advertising market. Any partnership with Google would mean that Microsoft will not go through with the buyout and the share price would collapse and bring on shareholder lawsuits. There are few companies big enough to buy Yahoo and no other company that has the synergies to make the a buyout offer above 45 billion.

Yahoo was trading at $34 per share recently but had dropped below $20 when the offer was made. The 62% premium is difficult to turn down. The most that Yahoo can do is to get a better price from Microsoft, say in the $35-$38 range.

How it affects Google
Google cant buy Yahoo because it already has a dominant position in search. What Google can do is to make it difficult for the buyout to go through. Yahoo and Microsoft are the leaders in Portals, Messenger and Webmail. A delay in the buyout and any problems in integrating the companies would give time for increase its lead in search. If Yahoo accepts the buyout, the best Google can do is use any confusion and uncertainty during the integration process to increase its lead. The approval for the buyout would take months and the integration of MSN and Yahoo would take longer. If Google manages to get to 75% of the market share before a successful MSN+Yahoo integration they win the search battle.

A new proposal
 In my opinion a better option would have been to create another company “MicroHoo”. This company would be a merger of Yahoo and the Internet division of Microsoft including the recent acquisition of Aquantive. The Microsoft guys would run the administration/finance/sales/marketing/monetization and the Yahoo guys would be the creative side developing the content/sites. In this scenario, Microsoft doesn’t have to pay the 62% premium or dilute existing shareholders. It might put in additional cash into the merged company so that it has a controlling 51% stake.

As a Microsoft Shareholder I worry about the expected cost savings from synergies. I also worry if the approval and integration can be done in time to challenge Google.
I hope Microsoft thought about a merged company before they decided to just buyout Yahoo. Its possible that a merger was proposed but the idea was rejected by Yahoo. I guess Steve Ballmer sees a big opportunity and thinks that any futher delay in combining MSN and Yahoo would give Google an insurmountable lead. Only time if this buyout makes sense.
This article is just my opinion please do not base any investment decisions based on the article.

To read Microhoo - Round 2 the follow up to this article click here


Disclosure: I own shares of Microsoft.