Microsoft/Yahoo Drama and Investing in Google

We sold our shares of Yahoo (YHOO) the week before last when the price hit our safety stop, which we were forced to place by the uncertainty surrounding a deal with Microsoft (MSFT).

Microsoft CFO Chris Liddell said in the April 24 conference call: "Our initial offer was an extremely generous [one].... The strongest argument that I've heard on why we should increase our bid, simply that we can afford to, is not one that I favor. We've yet to see tangible evidence that our bid substantially undervalues the company."

In response to Mr. Liddell's comments, I sent to subscribers last Sunday:

You can see why investors began thinking that maybe Microsoft will walk away from the deal with Yahoo.

Walking away now doesn't mean walking away forever, by the way. Remember that Microsoft tried to get Yahoo a year ago. That didn't work, so it waited a year and tried again. Maybe it won't work this time, either, but we could see it come back in six months when Yahoo's share price is $17 and shareholders have so pressured Jerry Yang for missing the chance to get $31 that the deal can happen at, say, $25.

We're at the end of Microsoft's deadline, so it has to decide soon whether to up the offer, launch a hostile proxy battle, or walk away.

It has said it doesn't want to up the offer because there is no reason to do so. It believes its offer is full and fair. Raising the offer now would be odd, and would leave Mr. Liddell with some explaining to do after his comments in last week's conference call.

A proxy battle looks senseless. It would drag on for months and the very talent that Microsoft seeks to get with Yahoo would flee the situation in droves, going to the open arms of internet firms around Silicon Valley. Both Microsoft and Yahoo would be distracted from their businesses while Google (GOOG) continues going to town.

That leaves walking away looking like a good option.

Should Microsoft cancel the offer and we see YHOO drop like a rock, there's a small chance we'll re-invest at lower prices if the partnership with Google looks like it might become something and/or a later offer by Microsoft appears likely.

Despite Mr. Liddell's saying that Microsoft's initial offer was "extremely generous," it got even more generous. On Friday, Microsoft upped its offer from $31 to $33 and it appeared that we'd made a mistake to have sold YHOO the week prior. Then, late last night, Microsoft withdrew its offer entirely.

Steve Ballmer said, "Despite our best efforts, including raising our bid by roughly $5 billion, Yahoo has not moved toward accepting our offer. After careful consideration, we believe the economics demanded by Yahoo do not make sense for us, and it is in the best interests of Microsoft stockholders, employees and other stakeholders to withdraw our proposal."

Jerry Yang wrote, "This process has underscored our unique and valuable strategic position. With the distraction of Microsoft's unsolicited proposal now behind us, we will be able to focus all of our energies on executing the most important transition in our history..."

Soleil Securities analyst Laura Martin said she expects shares of YHOO to fall $8 on Monday. Other analysts have predicted a swift return to $19, which would represent a 36% drop from their Friday after-hours price of $29.70.

What now?

Of course, we're glad to be out of YHOO shares. That's the immediate reason to raise a glass. Longer term, I continue to think this near match-up between Microsoft and Yahoo makes it clear that Google is the place for online investment dollars. It's the company that Yahoo is turning to for help in its comeback, and it's the company that scared Microsoft into offering more than $40 billion for Yahoo.

I think this saga isn't over yet. I think we'll see Yahoo struggle for a while longer and I hope very much that it succeeds. Our belief that it could was our reason for investing in the first place. However, Jerry Yang's 100 days for a turnaround ended a long time ago and we haven't seen much. The increased shareholder pressure now that the deal with Microsoft is off might light a fire under Mr. Yang -- or burn him out of his position entirely.

Regardless, if Yahoo gets back on its feet, it appears that it will do so with the help of Google. That will benefit Google. If Yahoo fails, I imagine that Microsoft will show up again with a lower bid for Yahoo and that it will succeed because Yahoo shareholders won't let it pass by again.

Through all this, Google's search share will grow, its progress with gDocs will move closer to offering an alternative to Microsoft Office, and we may even see a downloadable internet-based operating system from Google as the first potential threat to the Windows franchise.

Before the hate mail comes pouring in, realize that I do not expect Google to displace Microsoft before summer is out. That's not what I'm calling here. What I'm observing is that the Microsoft/Yahoo drama illustrates that the old guard is in a precarious position against the new, and that it gets even more precarious with each passing month.

Clearly, the old guard itself realizes that as well. If Microsoft is to remain a necessary part of computing, it's going to have to get online applications figured out quickly, build hooks to its online properties into its online applications, and hope that an integrated Microsoft web search capability from within its online application family can gain it some of Google's growing market share -- and the advertising revenue that goes with it.

Microsoft is now facing a future where more is done online than off, and where it has a spotty track record in the areas that matter. It had hoped that Yahoo could help it catch up. With that hope gone, it had better begin reconfiguring itself soon.

With an extra $40 billion in its wallet, the possibilities are tantalizing.

Comments

[Zeninvestor]

Well, Yang cost himself and his shareholders (not me I got out) a lot of money, and the distraction of the coming lawsuits when combined with the failure of 'Panama', the strong offerings by Google, and a recession either here or on the nearing horizon means SELL YAHOO!

As for the Board of Directors. SHAME, SHAME, SHAME! By not standing up to a foolish founder (who is already rich) they have harmed the many individual and institutional holders of the stock. They should be FIRED.

And, yes the 40B is better spent by MSFT to fight the battle alone. My new home page is IGoogle, goodbye Yahoo!

[Alik Yanchinov]

1. If I were Microsoft, I would hire people from both Yahoo and Google to develop my own platform. $40 Billion is enough to bribe anyone.
2. If were Microsoft, I had to think that I am a leader not a follower. What Microsoft does, it follows Google's steps. That's why Microsoft is destined to loose to Google almost always...
3. If I were Microsoft, I would be looking not only for talents who are very important, but ideas. Talents without ideas are a badly prepared dish: a lot of hubris and ambitions...
4. If I were Microsoft, I would fire the HR Director.
5. If I were Microsoft. But there is no point to continue; I am not Microsoft.

[rmgreenwald]

Yang may be a brilliant technical mind, but I question his leadership and business management acumen. He has failed to steady a floundering YHOO and it took the offer from MS to move the stock price higher. Is this another example of why you don't let the technical developers/engineers run the shop? I'm not going to be surprised to see YHOO twisting in the wind for awhile, as upset shareholders fume. I also can't help but wonder if MS is using a bit of Sun Tzu here:

"For to win one hundred victories in one hundred battles is not the acme of skill. To subdue the enemy without fighting is the acme of skill."

[Peter518]

Great call! Jason.

[rainman]

Yang, good job to push away the greedy wolf.
Next step, simple copy the approach to launch on Ydocs.

[delta7777]

Yahoo again exhibits the same mentality
...as when they refused to consider the ideas of Brin&Co
...as when they revised their finance message board format
...Again shows that involvement in a mismanaged company is a guaranteed loser...

[srw]

The sad thing about Microsoft is that they can't even build (from a technical perspective) a copycat version of Google adwords/analytics. Looking at adcenter and adcenter analytics you quickly realize that MS has not idea about how to build a web application!

If I were Microsoft, I would build a keyword exchange market instead of another adwords/overture/adcen... system, so you can empower many ad networks in one place. It can work like a stock exchange market.

[globalmacro]

Good call but you're way way too late. You should have been talking about Google's strong position back when Microsoft's dim-witted bid for Yahoo was first announced. Even to this day, I'm still surprised by how many analysts and TV commentators and pundits recommended buying Microsoft and Yahoo shares.

[Jason Kelly]

Globalmacro - Actually, the announcement of Microsoft's bid for Yahoo is precisely when I realized Google was the place to put online investment dollars.

We watched for the right entry price, and ended up investing at less than $500 per share. So, the Microsoft/Yahoo saga got us out of Yahoo at a profit and into Google at a bargain price, for which I'm grateful.

Here's my Feb. 4 article about the switch to Google: tinyurl.com/5ajer5

Here's my Apr. 18 article about Google vs. Microsoft in the software as a service battle: tinyurl.com/6xfeb2

Thanks to everybody for the comments.

[Muddling Investor]

Great two calls, Jason. I also thought that Google is a buy when deal was announced: muddlinginvestor.blogs....
Unlike you, I didn't act on it (partially because I am loaded on Google since 2005, partially because I thought that there will be possibility for some time. Wrong on both counts.

[globalmacro]

Thanks for those links. We started buying a bit early at 560 but we were buying all the way down to 430 so we were able to average down to around 485. I couldnt believe that the market put so much weight on comscore data. I almost started to doubt my conviction. I guess thats the power of negative sentiment.