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Click here for my initial analysis of the Yahoo buyout by Microsoft

With Yahoo rejecting Microsoft’s initial offer the ball is in Microsoft’s court. The letter from Ballmer seems to suggest that if the $31 bid is rejected that MSFT will go to Yahoo shareholders. I still think this deal can be done at a price between $35-$38. Microsoft could easily sell off the non-core assets of Yahoo to pay for the increase, Will it? As a Microsoft shareholder, I hope not. There are no other buyers for Yahoo and existing shareholders will push for a sale to get the 62% premium.

Should Microsoft Wait?
Some people have suggested that Microsoft can take the offer off the table. They can then buy Yahoo cheaper in a year’s time. The problem is with Google holding 56% market share and increasing market share every quarter there is very little time left. The proposed buyout will take 2-3 quarters just for Regulatory approval, add in another year to integrate Yahoo and MSN. If they wait for a year before they try to buyout Yahoo cheaper, then its almost 3 years that Google will have to improve and consolidate its lead. If Google reaches 70-75% market share the Search/Text Ads battle is over. The only thing that could break Google’s domination with 75% market share would be a revolutionary search engine that provides dramatically better results than Google.

Is Search the complete story?
While everyone focuses on search and text ad’s and Google’s lead in that market. There is something most overlook, the banner displays and rich content ads. Yahoo holds a big lead over Google in the Banner Ads. Microsoft could use Yahoo to build a big lead over Google in the banner Ad’s market. Microsoft may feel they can use the Aquantive platform to boost revenue from Yahoo sites faster than most people think. Microsoft may also be interested in the mobile platform Yahoo has developed. Their interest in the mobile ad platform seems obvious with todays purchase of Danger.

Disclosure: I own shares of Microsoft

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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.

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Google is the king of search engines but its kingdom under attack. The invaders are Microsoft’s Windows Live, Yahoo and the newly renamed kid on the block Ask.com.

Google’s advantage: At one time most search engines used to display a list of pages containing the search words without ordering the results by importance. The results were like searching for a needle in a bale of hay instead of a haystack, better but still a pain in rear. Then along came Google and its page rankings, the hay was gone. It has taken years for Yahoo, MSN and Ask.com to realise the importance of ordering results by importance and developing the infrastructure and algorithms to provide results comparable to Google.

Search by definition is imprecise since the search engine has no clue what you’re really thinking about. If you type in Apple are you searching for the Fruit or the Company? The search engine has no idea, neither do the advertisers. The only person that knows is you. Google still returns better results but the difference is negligible.

Yahoo: Losing to Google
Lets get this one out of the way. Yahoo is getting its ass handed to it on a plate by Google. Its losing to Google in every aspect from search, functionality, user experience and on the financial side too.

Microsoft: The threat from Vista
The Microsoft threat is not from its search engine but from Internet Explorer 7. Here is a quote from the Internet Explorer features page

“Internet Explorer 7 brings your favorite web search providers to you. With the built-in search box, you can search the web at any time without having to open a search provider page. You can display search results in a separate tab, and then open the results in other tabs to quickly compare sites and find the information you want. You can even customize your search by setting your favorite search provider as the default.“

As most of you have probably guessed the “default search provider” is Windows Live. What a surprise. So every installation of Vista is potentially a lost user for other search engines. Most users wont bother to change search engines if the default one gives results that are good enough. Search engines can negotiate deals with PC manufacturers to get their search engine set at the default. This will cost money since HP, Dell, Sony wont be providing the service for free. Any future re-installs on these computers from a retail copy of Vista will reset the default back to Windows Live.

Easy to access was another minor advantage that Google had. Type in Google and hit Ctrl+Enter to go to the Google site was easier than “search.msn.com”. Now you just need to type in “live” and hit Ctrl+Enter to get to the Microsoft engine.

Ask.com: A better user experience
Search engines are no longer about getting users a relevant result. All search engines do that. Engines need to differentiate themselves by providing unique features and assisting their users manage the results. Ask.com has done a phenomenal job of differentiating itself. Personally I love the binoculars which give a quick view of the site in a pop-up. I also like the “Narrow your Search”, “Expand your Search” and “Related Names” sidebars. Ask.com also has a nice feature (probably from when it was called AskJeeves.com” where you can ask a question and it will try to answer the question along with providing search results. For all of these reasons Ask.com is the fastest growing search

Conclusion: Google is a good company with good earnings and growth but its dominance is under threat from Microsoft and Ask.com. I prefer IACI for its Ask.com search engine which has a better user experience and is growing faster than Google. While Google is a one trick pony IACI has a diversified economic float and a brilliant CEO in Barry Diller.

Conflicts : I own shares of Microsoft and IAC/Interactive Corp

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