Bill Miller: Microsoft Will 'Need To Enhance Its Offer' to Yahoo

Legg Mason portfolio manager Bill Miller says Microsoft (MSFT) “will need to enhance its offer” to Yahoo (YHOO) “if it wants to complete a deal.” On the other hand, he also says “MSFT will do what it takes” to complete the deal, and that “it will be hard for YHOO to come up with alternatives that deliver more value than MSFT will ultimately be willing to pay.”

Legg Mason Capital Management is the second-largest Yahoo holder, with over 80 million shares.

Miller made his comments in a quarterly letter dated February 10 to investors in the Legg Mason Value Trust, a mutual fund.

Here is the complete text of the section of the letter that address Yahoo and the Microsoft bid:

On January 31, Microsoft made an unsolicited offer to acquire Yahoo at a price that represented over a 60% premium to where YHOO’s shares were trading. LMCM is YHOO’s second-largest shareholder, owning over 80 million shares. Subsequent to the deal being announced, we have met with Steve Ballmer, MSFT’s CEO, and spoken with Jerry Yang, CEO of YHOO.

YHOO’s Board has pledged to give the offer careful consideration and to do what they believe will deliver the most long-term value to YHOO owners. That is the right message, and we are waiting to hear their views as they develop. That said, we think it will be hard for YHOO to come up with alternatives that deliver more value than MSFT will ultimately be willing to pay.

We think this deal is a strategic imperative for MSFT, and that YHOO is in a tough spot if it wishes to remain independent. It has been reported that MSFT has been discussing a combination with YHOO for well over a year, and that it had been prepared to pay over $40 per share previously. We have no way of knowing whether those reports are accurate or not.

Our own valuation work puts the value of YHOO in the range of those reported numbers, though, and we think MSFT will need to enhance its offer if it wants to complete a deal. YHOO shares were recently trading at a four-year low, and the stock averaged above the current offer price for all of 2004.

YHOO is a uniquely valuable asset, and we expect MSFT will do what it takes to acquire it.

One last point: the 60% premium MSFT offered for YHOO highlights what we believe are the significant opportunities present in our portfolios. Clients and shareholders are understandably disappointed when the performance of their portfolio does not keep pace with the broader market. But the price of a publicly traded security is one thing, and its value is something else. Price is a function of short-term supply and demand characteristics, which are heavily influenced by the most recent news and results. Value is the present value of the future cash flows of the business, and that is what we focus on. We believe the values in the market today are as attractive as they have been in the past five years, and patient long-term investors (including the Fund) should be well rewarded for putting money to work right in here.

Here’s a list of the top 10 holdings in Legg Mason Value Trust as of December 31:

• Amazon (AMZN) 6.9%
• AES Corp. (AES) 6.2%
• United Health (UNH) 5.9%
• Aetna (AET) 5.2%
• J.P. Morgan Chase (JPM) 4.7%
• Qwest (Q) 4.1%
• Sprint Nextel (S) 3.9%
• eBay (EBAY) 3.5%
• Yahoo 3.4%
• Google (GOOG) 3.2%