One of my friends who formerly worked at Yahoo still holds some shares of the company. He knows I have liked Microsoft as a stock and asked me to write him a quick note on the Microsoft bid for Yahoo. As a Yahoo shareholder, how does he decide whether to sell or hold? What’s the analysis?
The first part of the question involves some simple numbers: what's the tax basis and impact? If he sells now, he pays his 20% in taxes on the gain (depending on whether it’s long term or short term). If he holds and it does go through, it should go through at a roughly 10% higher price ($31 vs. $28), and he can possibly roll his tax basis (check this with your tax advisor, as the proposed deal is half cash and/or half stock – but I believe it is intended to be tax free at least for the stock portion). If he holds and it doesn’t go through, Yahoo could well give back the 50% it has traded up.
There is a reasonable likelihood of failure of the deal, as these discussions between Microsoft and Yahoo are not new. But perhaps the risk of failure is no worse than 50/50. The market has essentially said it believes there is a greater than 70% likelihood on the deal going through, or Microsoft getting beat out by someone else - this, based on a $31 offer price, $19-20/share previous price, and a Yahoo price that traded up immediately to $28. I can't see anyone else easily outbidding Microsoft at this scale (though Microsoft may well have to sweeten the deal), as Google would have antitrust issues, and while that’s always a possibility, too, it's not too likely.
So we are left with perhaps a 10-20% upside versus a 50%+ downside, and our market estimate of a 70%-75% likelihood of the upside. This analysis would argue possibly for a sell rather than a hold, but not by much.
But I still think from a product perspective a Microsoft/ Yahoo combination could be a formidable challenge to Google and deliver long term growth to Microsoft – in which case holding gets him Microsoft stock at up to a 20% discount from where it is today, 10% from Yahoo’s current trading price discount to the $31 offer. Depending on the tax analysis and your basis, that's likely another 10%+ on the tax deferral. Think about it – a Yahoo portal, instant messenger, search, advertising, groups, and all bundled directly to my desktop – and tied long term into my corporate back office. Very intriguing.
I am personally invested in Microsoft at around $24/share, and like it as a buy probably up to $35 or so. I have never owned Yahoo. But if I were a Yahoo shareholder, I'd see Yahoo’s PE generally trading in the 30s, and currently at 50+ on the back of this announcement, while Microsoft’s has been in the mid-teens. So, if you are Yahoo shareholder and hold through a deal, you also get a much cheaper stock in the bargain.
No real answers here, just the analysis.