Buying Yahoo Now Is Purely Speculative; Any Takeover Discussion May Easily Fall Apart

Oct.25.11 | About: Yahoo! Inc. (YHOO)

“Overheard...Netflix (NASDAQ:NFLX), RIM (RIMM), and Yahoo (NASDAQ:YHOO) merging to provide streaming old movies to blackberries with lots of pop up ads” – Howard Lindzon

Lindzon’s comment on Yahoo summarizes the company’s woes nicely. Yahoo’s business feels dated, and this showed up in its most recent results. With the exception of Yahoo Finance and original video content offered by Yahoo, there is little reason to be excited about the company. Investors would disagree: Yahoo is up 50.68%, closing most recently at $16.71 on speculation that Google Inc. (NASDAQ:GOOG) is in the running for buying Yahoo.

The only problem with Google working with private equity investors in buying Yahoo is that regulators would probably not allow this to happen. Google has a 68% market share of the search market. The joint market share of Bing and Yahoo was 20.36% (in the U.S., Bing’s market share is 14.7%). Google’s direct plus indirect control of the search market would total 88%.

Microsoft (NASDAQ:MSFT) is another company considered a likely candidate for buying Yahoo. Citing the company’s failure to buy Yahoo for over $30, investors failed to recognize that the Bing-Yahoo partnership cost Microsoft $5.5 billion since the search engine was launched in 2009. When R&D costs associated to Bing prior to its launch are included, Microsoft spent more than $9B on this division.

From an accounting perspective, it makes little sense for Microsoft to buy Yahoo. If Microsoft is worried that Google will seriously play a contentious role in acquiring Yahoo, then a Microsoft takeover would be possible.

Bottom Line:

Yahoo’s revenue did not grow in its most recent quarter. Yahoo has 13,600 employees, and is in the process of restructuring its sales force. Its sites are plagued with system glitches, and the site still uses pop-up ads. For example, users frequently encounter “server error” messages in the comments section on Yahoo’s articles.

Yahoo shares already rallied to $16.71, which is within its 2011 trading range price of between $16 and $18. Buying Yahoo now is purely speculative, and any takeover discussion may easily fall apart. The European crisis will further remind investors that “risk-off” will reduce the trading premium already priced in Yahoo’s shares.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.