Microsoft / Yahoo: Round Two

Rumor has it that MSFT is kicking YHOO’s tires, again, but this time it’s only going after the search component of the business. We know search is key because it accounts for 40% of the only remaining bright spot in advertising, but also because it is seen within MSFT’s walls as a “platform”. From FT, via GigaOm:

“People don’t understand what they’re talking about,” Ballmer told the FT. “At the end of the day, this is about the ad platform. This is not about just any one of the applications.” And for Microsoft, according to the interview, the primary ad platform is search. That makes sense as search is a billion-dollar, proven business.

The rest of Yahoo! is suddenly seen as undesirable, for what I think are two main reasons:

• In the short term (2009), some are calling for a softening of display banner inventory rates, and while video is the fastest growing segment of digital media, it is not as if Yahoo! is necessarily at the forefront of it, YouTube is. This is actually shocking because just a few years ago Yahoo! ruled this space, but I digress.
• More importantly, MSFT made a huge stink about Google’s bid to essentially take over Yahoo!’s search, citing monopoly concerns. As such, MSFT fears that merging MSFT’s and YHOO’s communications platforms - namely email - would give Google something to complain about. Seeing how email is certainly not monetizable, it is not worth the fight.

I personally think the second rationale is smart, in a cautious sort of way. I however think that MSFT needs all the help it can get in online content, portal strategy etc., but who ever listens to me, right?

The Achilles’ heel to this rumored deal, however, is the complexity of the structure. In fact, complex doesn’t even start to cover it:

Under the terms of the proposed transaction, Microsoft would provide a $5 billion facility to the Jon Miller and Ross Levinsohn management team [editor’s note: Mr. Miller ran AOL, Mr. Levinsohn ran FIM]. The duo would raise an additional $5 billion from external investors.

This cash would be used to buy convertible preference shares and warrants which would give it a holding in excess of 30% of Yahoo.

The external investors would also have the right to appoint three of Yahoo’s 11 board directors. The talks with Yahoo involve Microsoft obtaining a 10-year operating agreement to manage the search business. It would also receive a two-year call option to buy the search business for $20 billion. That would leave Yahoo to run its own e-mail, messaging, and content services.

It is expected that the operating agreement would boost Yahoo’s income by as much as $2 billion per annum.

You got that? There’s a quiz next week… I think the world can do without complex financial engineering for a while, don’t you?

Either way, it is worth noting that during his tenure with Fox Interactive Media, Ross Levinsohn orchestrated a deal between News Corp.’s FOXSports.com and MSN which propelled FOX Sports to the upper echelon of sports sites and gave him a lay of land within MSFT’s online division. Does this matter? Sure, why not. It does not hurt.

It also does not hurt that his confrere Jon Miller ran AOL, which sooner or later will merge with Yahoo! I figure down the road when the massive consolidation takes place, it’s highly possible that AOL, Yahoo! will both be units underneath MSFT… and one reason will be Google’s aversion to owning content whereas MSFT has grudgingly dipped its toes in content (Slate.com before it sold it to Washington Post, to name one, but also all of the content on MSN.com, to list other examples).

Ultimately, I really think that when push comes to shove, if MSFT is willing to pay $20B for search (I cannot stress this enough: this is merely a rumor still), then why not pay $25B for the whole kit and kaboodle? It won’t be $44.6B, that is for sure. I should disclose that I owned Yahoo! shares when MSFT first made a bid for YHOO but then sold them at $29 when it became clear that YHOO’s then CEO Jerry Yang would torpedo the deal at any cost. No, really, any cost, try $25B or so, which is the value between Yahoo!’s market cap when he resigned this month and the buyout price MSFT offered.

But the main reason why this will perhaps end in a buyout is that the financial markets remain somewhat frozen and raising $5B won’t be easy (for Levinsohn and Miller). It is easier for MSFT to write a big check than wait for a third party to raise $5B to go along with MSFT’s own $5B… so this might be just one move by MSFT to make it seem like they really don’t want all of Yahoo!, and when no one else will be able to match their capital, they will “be swayed” to sign a check for the whole thing themselves.

Just my two cents.

Comments

[JEFF G:]

Now I see why MSFT last week said they go out raise debt via shelf registration. They were planning to buy yahoo search biz right away. It should have been more obvious to us. I saw the story and knew that MSFT would eventually do a yahoo deal but never put the 2 together...

2008 Nov 30 08:45 AM

[TopViet:]

MSFT really want a market share in search engine from Yahoo to compete with Google.

2008 Nov 30 11:38 AM

[Sam Liu:]

Yahoo's search does not compare yet to Google's accuracy

2008 Nov 30 01:27 PM

[Sam Liu:]

but microsoft search, mail and website all are lousy. I am so exasperated by vista, that I'll probably buy a non- msft os computer

i'm glad if this transaction transpires, that msft is not burdened by yahoo or bill gates or jerry yang.

note: I cheer Craig mundie and ray Ozzie, I am a Msft stock holder

2008 Nov 30 01:36 PM

[Fam62c:]

I use Yahoo as my home page and have for years, there's a lot of good stuff on it and I think a lot of people use it. I have to believe that there is value in the Yahoo! brand name even beyond search. I think with the right management team and increased marketing to increase brand awareness Yahoo could be a good company again. The former CEO did a lot of damage to the company and I'm glad he's gone; maybe they will have a chance from here on.

2008 Nov 30 08:36 PM