Proposed Combination Call
February 1, 2008 8:30 am ET
Larry Cohen - General Manager of Corporate Communications
Steve Ballmer - Chief Executive Officer
Chris Liddell – Chief Financial Officer
Kevin Johnson - President of thePlatform and Services Division
Ray Ozzie - Chief Software Architect
Brad Smith - General Counsel
Charles DiBono - SanfordBernstein
Heather Bellini - UBS
Sarah Friar - Goldman Sachs
Imran Khan - JP Morgan
John Difucci - Bear Stearns
Brent Hill - Citi
Atthis time I would like to welcome everyone to theMicrosoft conference call. (OperatorInstructions) At thistime, I would like to turn thecall over to Mr. Larry Cohen. Sir, youmay begin your conference
Thank you, operator. Good morning, everybody. I'mLarry Cohen, General Manager of Corporate Communications atMicrosoft. With methis morning are SteveBallmer, our Chief Executive Officer; Chris Liddell, our Chief FinancialOfficer; Kevin Johnson, our President of thePlatform and Services Division; RayOzzie, our Chief Software Architect; and Brad Smith, our General Counsel.
Earlier this morning, Microsoft announced its proposal toacquire Yahoo!. Acopy of the pressrelease we issued as well as aslide presentation for today’s conference call can befound on our website atMicrosoft.com.
Before we begin, I want to read thefollowing: this announcement is neither anoffer to purchase nor asolicitation of anoffer to sell shares of Yahoo! or Microsoft. Microsoft will file aregistration statement on FormS-4 with a proxystatement and prospectus with theSecurities and ExchangeCommission which will beavailable at no costto Yahoo! shareholders atwww.SEC.gov. Yahoo! shareholders areencouraged to read thestatement on Form S-4when it becomesavailable.
This announcement includes forward-looking statements,including statements about our beliefs and expectations regarding theproposed business combination of Microsoft and Yahoo!. Thepotential costs and benefits of any such transaction and potential synergies ofthe proposedtransaction and actual results could differ materially.
Additional information concerning factors that could causeactual results to differ materially from those projected inany forward-looking statements will becontained in theS-4.
With that, I amgoing to now turn thecall over to Steve.
Thanks, everybody. Thanks for your time. We're allvery excited about today's announcement. We see thisannouncement as being significant for our joint shareholders, customers andemployees. We also seethis announcement as thenext major milestone inMicrosoft's companywide transformation to embrace online services overall, andto invest very successfully insearch and advertising.
As you may have seen inthe information wesent out earlier today, we've been engaged inconversations with Yahoo! management off and on for thelast 18 months. Last night I calledJerry Yang to discuss our proposal. This is aproposal we believe to bea very good deal forYahoo!'s shareholders and anoffer we want them to think about seriously, to beexcited about and particularly to have theYahoo! employees bevery, very excited about.
If you look atMicrosoft and Yahoo!, our companies really doshare a vision for thepotential of online services, and advertising specifically. When you combine thestrengths of our two companies, theresult will be anincredibly efficient and competitive offering for consumers, for advertisersand for publishers.
There arenow several steps we'll both need to take inorder to successfully moveforward. We arevery committed to this. Ayear ago, the Yahoo!management team told us itwasn't really theright time to discuss anacquisition. We believed then inthe benefits ofcombining the twocompanies and we believe now inthose benefits more than ever. That's why we're making itpublic today, so bothsets of shareholders, employees and customers can understand theincredible opportunity inthe combination ofMicrosoft and Yahoo!.
This is adecision we've thought -- and I’ve personally thought -- longand hard about. We're very, veryconfident that it's theright path for Microsoft and for Yahoo!.
I'd like to turn things over to Kevin Johnson to saya few words about theindustry opportunity and dynamics, and more specifically, some of thebenefits we see inthis combination.
Thanks, Steve. Let mejust start with opportunity. Theonline advertising industry is avery large industry today atover $40 billion and it's forecasted to growquite rapidly to reach nearly $80 billion inthe next threeyears. Online advertising not onlyrepresents asignificant growth opportunity, but itis also a criticalelement of thebusiness model for monetization of consumer Internet services; Internet services we create and Internetservices of our partners.
At theJuly 2007 financial analyst meeting, I shared our view of theindustry value chain,the analysis of thatvalue chain, aframework for the userservices, and aframework for theunderlying advertising platform. We havecontinued to execute against that plan that was discussed atthe financial analystmeeting with thesuccessful integration of aQuantive, expansion of thebase of publishers using our ad platform; anew, integrated suite of our Windows Live services; animproved live search service and continued engagement of users on our MSNportal.
Now there area few keydynamics in theonline advertising industry that I think areworth noting. First, this is abusiness that hasscale economics in afew key areas. Scale economics insearch and ad serving, and scale economics inthe capital needed tosupport these areas; CapEx for data centers, servers and infrastructure.
Second, this is abusiness where technology matters. It's asoftware problem. It's about engineeringand R&D expertise and growing thecapacity that is really critical to thesuccess related to achieving scale.
Third, this is abusiness that requires significant investment inservers, data centers and infrastructure to support thehigh scale services. Because of thesedynamics, scale economics, thetechnology-driven nature of this industry and thecapital investment, you seethis industry going through aperiod of consolidation.
Today, themarket is increasingly dominated by one player. By combining assets of Microsoft and Yahoo! we can offer amore competitive choice for consumers, advertisers and publishers. Thefact is the industrywill be better servedby having a morecredible alternative inareas of search and advertising.
Let menow speak to thesynergies that this combination creates. The first isaround expanded R&D capacity. We candrive synergy by combining our engineering talent pools. Today, engineering resources work on many of thesame problems. You look across our twocompanies and there's two search indexes, two ad platforms. By combining our engineering talent, we'regoing to enable more innovation across awider range of priorities. Thisincreased capability will enable enhanced user experiences, increase searchinnovation and enable new capabilities inthe advertisingplatform. Allof this leads to better value for customers whether they're consumers,advertisers or publishers.
Thesecond pillar of synergies is around focusing engineering resources on many of theemerging user experiences. This expandedR&D capacity can improve our ability to drive innovation inemerging areas such as video, mobile and online commerce. Ray Ozzie will talk about this ina little bit moredetail.
Third is around scale economics. This combination enables us to eliminate duplicateCapEx related to theinfrastructure of servers and data centers that support search, thead platform and these user services. Bycombining the twocompanies' search and non-search advertising inventory onto asingle ad platform, revenue yield will improve. These scale economics enable amore efficient operation, better value for advertisers and agencies, and abetter value proposition for publishers.
Thefourth pillar of synergy is around operating efficiencies. This is anarea where synergies arecreated by ensuring that we eliminate redundant operating expenses. Part of this is ensuring that we have theright people in theright jobs and theright amount of headcount allocated to each function inthe business.
Theimpact of these four synergies will drive important value for our customers andshareholders. We have developed avery clear integration plan that will include leaders from both companies and avery clear set of principles to bring thecombined entity together.
Theintegration approach we aretaking is based on thesuccessful integration that we've had aQuantive and Tellme and bringing thosetogether with the Microsoftonline businesses.
Let menow hand it over toRay Ozzie to talk abit more about thetechnology assets and experiences.
Thanks, Kevin. Over thecourse of the past tenyears our lives, our businesses, even our society hasprogressively been transformed by theweb. Theearly web grew through theexplosion of information portals as our gateways to content and commerce andalso through simple communication tools such as email and IM, enabling us tosend messages to one another across theglobe.
But since then, theweb has evolvedtremendously. Beyond theportal, search now plays apivotal role in how wefind information, how we research, how we shop. For the mostpart, search is still tenblue links but innovations will transform thesearch user experience and theway ads aredelivered whether inspecific verticals, inmobile search or even innatural language search; innovations that will benefit users, advertisers andpublishers alike.
On thecommunication side, theweb has also evolvedtowards social media and social platforms that use relationships and ourcollective online behavior to transform how we stay informed, how we find andshare media, and how we communicate and interact with one another on theweb. This social platform willprogressively become anew entry point to allthat the web canoffer. Before long, these sametechnologies will even transform theproductivity side of our lives as thesocial platform enters theworkplace.
Since its early years, Yahoo! Hasplayed a keyrole in thegrowth and evolution of theweb. We have tremendous respect for theengineering team and thework that they've done. They've beenpioneers and leaders inbuilding compelling, high scale services and infrastructure. Yahoo! hastremendous community and content assets and by combining these with Microsoft'sexperience and our own assets -- assets ranging from personal and businessproductivity to entertainment and devices -- we can further accelerate thetransformation for allusers to a more socialweb.
We respect thework Yahoo! has done inthe realm of creating anopen development platform through its Yahoo! Developer Network and look forwardto extending this great work to aneven broader base of developers.
Moving forward, we believe acombination of Yahoo! and Microsoft will enable us to deliver abroad range of new experiences to our customers that neither of us would haveachieved on our own. Sowe're excited about this opportunity; anopportunity to collectively deliver compelling, seamless experiences thatcombine the power of theInternet with themagic of software across aworld of devices.
Now I'd like to hand itover to Chris Liddell who will briefly summarize thetransaction.
Thanks, Ray. Let mejust talk a little to theheadline numbers and some of thekey financial featuresfor you. Firstly, theoffer is for $44.6 billion. That's basedon our offer price of $31 ashare. Theoffer is for a mix of50% cash and 50% equity, with theequity equal to 0.9509 Microsoft shares based on our closing price atthe end ofyesterday.
We arelooking to targeting to close thetransaction in thesecond half of this calendar year '08.
Interms of the offeritself, we believe it's extremely attractive for both Microsoft shareholdersand Yahoo! shareholders. From aYahoo! shareholder perspective, itis a 62% premium totheir closing price atthe end of yesterdayand when you look atYahoo!, a large partof their underlying value is their stakes innon-operating businesses. When you look atour offer relative to its operating assets, itis a greater than 100%premium.
We also believe it's attractive to Microsoft shareholdersbecause of our potential to drive synergies and we seethe opportunity todrive at least $1billion of synergies based on theareas that Kevin Johnson outlined.
We also seethat the transaction,we believe, from anEPS point of view will beeither breakeven or better for Microsoft inthe second full fiscalyear post-closing. Those aresome of the accountingand synergy bases. Thereal opportunity from our perspective is to drive long-term economic value forour shareholders.
With those headline comments, I will hand itback to Larry and I believe we're going to take some questions.
That's right, operator. We are going toopen it up forquestions now.
(Operator Instructions) Your first question comes from CharlesDiBono - Sanford Bernstein.
Charles DiBono - Sanford Bernstein
This is probably most directed atSteve here. When you did theaQuantive deal last summer itseemed to reduce theneed for a largetransformative acquisition like this. Can you talk about now pursuing Yahoo! inthe context of whatyou've already done interms of assembling assets inthe online business? Isthere any kind of read-through from now, going after Yahoo! to how thoseacquisitions have fared and how they have repositioned your company?
In asense, there are threeconstituencies, as Kevin described, and we need to continue to build criticalmass with all three:consumers, advertisers and publishers. Our aQuantive acquisition was agreat step forward, particularly with advertisers but we also picked up some publisherassets that we liked. Of course, there wasno consumer face to that. Atthe end of theday, the linkage -- thecritical masses, consumers, advertisers, advertisers and publishers, publishersand advertisers, consumers -- those allkind of mix together.
Certainly from aconsumer perspective -- also from anadvertiser perspective and apublisher perspective, but from aconsumer perspective -- there's no better way to increase scale and capacitythan this acquisition.
Your next question comes from Heather Bellini - UBS.
Heather Bellini – UBS
Typically, revenue synergies insoftware deals have been elusive; atleast that's what us inthe industry would atleast remember. Can you talk with us alittle bit about therevenue synergies you would expect? Why you would expect to getthem? Over what timeframe we can expect to seethem, have this play out? Thank you.
I'm going to let Kevin take this. I will highlight this is asoftware-based business. It's anadvertising revenue game. Thedynamics of advertising revenue arevery much different than thedynamics of software revenue.
Heather Bellini – UBS
Right. That's why Ithought it would behelpful to put it intoperspective for everyone.
Heather, theonline advertising industry is anindustry where scale matters. Scaleeconomics come into play indriving yield of ad serving, whether it's search or non-search relatedads. By aggregating critical mass ofinventory on a singlead platform, itenables that ad platform to drive higher yield for publishers.
There's aset of things when you look atthe synergies, thescale economics, some of those scale economics can kick infairly rapidly when you just look atthe simple step ofjust combining thesearch-related ad inventory on asingle ad platform. Other areas of thescale economics and revenue opportunity aregoing to come longer term as we continue to build out more capability andinnovate around things like behavioral targeting, that's going to unlock morevalue from a revenuestandpoint.
Scale matters and there aresome things that areshort-term scale economic growth and other things that will belonger term that this innovation, this combined engineering force, can drive.
Heather Bellini – UBS
Looking where your margins are, your operating marginsversus Yahoo!'s, how fastif you are successfulonce the deal closes, howfast doyou think we can see themargin for thecombined company ramp back, which would appear alot closer to thecorporate average?
I don't think that's agood way to think about it. Thisbusiness will have different economic dynamics than Windows. Itwill have different economic dynamics than our entertainment and devicebusiness. I think relating things tocorporate average is probably not agood way to think about it, I think.
As I have said inother context of other businesses, insome senses we have atleast four different business models now inside Microsoft that allneed to be modeledseparately.
Heather, one of thethings at thefinancial analyst meeting inJuly when I showed theframework of the valuechain analysis, wesegmented this entire industry into aset of end-user service categories and theunderlying ad platform and I showed our view of therevenue size of those and each of those elements of that taxonomy havedifferent operating characteristics and different operating income.
If you refer back to that FAM meeting, itat least gives you asense of this particular industry and thefinancial dynamics behind it.
Heather Bellini – UBS
But clearly margins should bemoving up significantly versus what you have been reporting inthis segment?
I think you have to look atthe company as I have talkedabout in thepast, in threedifferent ways: our corebusinesses of our client and –
Heather Bellini – UBS
I'm just clearly looking atit right now inthe OSB segment.
We've been losing money. Our plan here would not beto lose money in thefuture. That would becorrect.
Heather Bellini – UBS
That helps. Thank you.
That would bemargin improvement.
Operator, let's go on to thenext question please.
Your next question comes from Sarah Friar - Goldman Sachs.
Sarah Friar - GoldmanSachs
Any thoughts on whether this could become amore competitive process? What makes Microsoft abetter buyer than one of thelarger media companies?
A secondquestion on theprice. As you think about is this abest and final offer, probably aneasier way to ask itis what are some of theother factors you might consider here on coming to afinal offer price with Yahoo!?
Clearly we believe theoffer is a veryattractive one from aYahoo! shareholder perspective. Westruck it ina way that we thinkwill make itattractive and that's our perspective on it.
Sarah Friar - GoldmanSachs
On thecompetitiveness of theprocess, maybe why Microsoft over some of themedia companies that could take alook at Yahoo!?
Obviously, any number of companies might have aninterest. We've clearly made avery compelling offer. Thereaction from publishers -- which include alot of the mediacompanies -- has beenvery positive. They've been encouragingus to make this kind of acquisition. Infact, we've been getting unsolicited feedback this morning from publishers andadvertisers that this is theright kind of step that's going to create amore compelling and competitive number two inthe marketplace.
As I said, any number of companies might take aninterest. I think there's really onecompany that cannot; that's Google itself. Given that Google hasroughly a 75% marketshare worldwide for online paid search they arenot in aposition to dothis. Given its super dominant marketshare, Google is clearly prevented by theantitrust laws from buying Yahoo! or buying this business from Yahoo!.
Your next question comes from Imran Khan - JP Morgan.
Imran Khan - JPMorgan
Kevin, one ofthe biggest challengesthat Yahoo! Faced over time was their losing search market share. As you aretrying to buy this company, what doyou think that you can dothat will stop losing such market share? You talked about getting scale on themonetization and themarketing side; but how doyou stop losing search market share?
Steve, if you look atYahoo! they have assets inJapan and Chinawhere they have aminority investment. What is your view about those assets? Doyou keep them or doyou try to think about divesting them?
Clearly we think thesynergy around expanded R&D capability helps us geta broader reach oninnovation in newareas that will help us drive breakthroughs insearch. Thefact is today we have got two engineering forces inour companies that largely arefocused on many of thesame problems around crawling theweb, the coresearch relevance algorithms and many of thethings related to search. By combining these engineering forces, we can bemore efficient in theengineers that areallocated and really focused on driving thecore relevance andbring up engineers to drive more innovation inthe area of searchverticals, search user experience, thesocial media aspects of search. Socertainly there is work that hasto be done that goesinto that, but this combination of resources we think really positions us wellfor that opportunity.
With respect to theminority interests Yahoo! has, those arecomplex relationships. They areminority investments but atthe same time, theYahoo! brand is run through Yahoo! Japan and Softbank inJapan; similarlywith Alibaba in China. I think our basic approach there would beto buy all of Yahoo!,understand those relationships and thedefault would not beto make any change inthose relationships, but I'm sure we'll learn more as we getinto it.
Your next question comes from John Difucci - Bear Stearns.
John Difucci - BearStearns
You talked alot about scale and thereason for doing this but couldn't you have simply expanded R&D capacitygiven your balance sheet and especially given therisk in integratingwhat appear to be twocompanies with vastly different cultures, especially since you have to listfour synergies to go through to make this make alot of sense. Was that risk ofintegration accounted for when you calculated that atleast $1 billion of synergy?
I think therisks -- any large integration process hasrisks associated with it. I know we haveall thought aboutit. Sure, we could have hiredengineers. We're very good atthat. We have been hiring engineers but atthe same time, themarket continues to growand the leadercontinues to consolidate position.
There's nothing quite like putting together and having achance to put together two larger, sophisticated R&D organizations. There's alot of great talent. We're veryrespectful of what Yahoo!'s accomplished, not only insearch and advertising, but inmany of the otherareas. Putting these things together with agreat integration actually should bequite an accelerant toprogress.
I believe theemployees in our twocompanies really share acommon passion for innovation and utilizing technology to create great userexperiences and value inthis online advertising industry. Ithink that common passion is theopportunity we have together with employees inboth companies to really combine ina way that makes notonly strategic sense but good financial sense as well.
John Difucci - BearStearns
So itsounds like time to market to really weighed inhere and that makes sense. But this is abid for Yahoo!, andthey issued a pressrelease and they're mulling itover, I guess. I amjust curious, as this hasbeen talked about for quite some time; why couldn't you have waited alittle bit longer to getthis so it's afriendly deal out there and itgets done pretty much right away?
Look. We believe inthis combination now more than ever. We havemade a greatoffer. We respect thefact their board and management team hasa lot to consider, butwe look forward to thedialogue.
Your final question comes from Brent Hill - Citi.
Brent Hill - Citi
Steve, just regarding theexisting brands of Live and MSN, how areyou thinking about that post this acquisition?
Let metake that and I'll let Steve punctuate. Look, theYahoo! brand is agreat brand. We love theYahoo! brand. Part of our integrationprinciples and thelearning and working with aQuantive and Tellme is that we want to have clear integrationprinciples and a jointleadership team of Microsoft leaders and Yahoo! leaders to really work through thethoughtful process of how you land thespecifics on this.
We have got clear line of sight to thesynergies and thevalue creation we aregoing to unlock. We have got aclear set of principles and we're going to go through athoughtful process with great talent from both Yahoo! and Microsoft to really makethe specific decisionson how that lands.
Windows, software plus services, sometimes people read thatwhen we say itas search and advertising and portal. Itreally represents atransformation of our business. TheWindows user wants to belive. TheWindows experience needs to increasingly embrace theInternet. There will bea Windows Live; Office,there will be anOffice Live as we continue to bring out innovations inwhich Office transforms and is transformed by theInternet.
Socertainly Windows Live, Office Live, Yahoo!, those areall, I think, powerful opportunities, powerful brands. Exactly how we relate MSN and some of thoseother things, we have some thoughts but as Kevin said, ateam from both companies would bebest prepared to assess that.
Brent Hill - Citi
Just as you look atfurther acquisitions, hasthis pretty much put on hold anything you aredoing on theenterprise software side inthe near term?
Thanks everyone for joining us. Bye-bye.