I Think Icahn: Time for Yahoo's Yang to Play Chicken?

Most people think Yahoo's (YHOO) Jerry Yang is screwed. They argue that he has few, if any, options at this point. He either tries to renegotiate a deal with Microsoft (MSFT) or his days working at the company he founded with David Filo will soon be over.

Can Icahn Gain Control of the Board?

Icahn and Paulson only control about 110 million shares, but Legg Mason, Capital Research and Capital World Investors control about another 250 million shares. That’s about 350 million shares total. Icahn has publicly stated his intention to buy up $2.5 billion of stock or approximately another 40 million shares. With commitments from other hedge funds, Icahn may still not have a guaranteed 700 million share voting majority.

But he doesn’t need it. Other mutual funds own large blocks of stock. Institutional holders and mutual funds control 73% of the stock. These holders cannot merely sell all their stock at once on the open market without driving the stock price down. Furthermore, they don’t want to miss the upside if Icahn is successful, and they certainly don’t want to be holding the stock if Microsoft and Icahn both walk.

So Icahn has shrewdly forced their hand into supporting his efforts (assuming Legg Mason and Capital Re go along). To maximize their return, they really must support Icahn, hopefully selling all their holdings at a premium. And remember, Icahn doesn’t need all their votes; he needs only about 20-40% of them. So yes, he can get control.

What Does Icahn Want?

You can’t judge M&A deals based on the public posturing. All the public letters and comments are drafted and orchestrated by lawyers to keep each side clear of other legal issues. Do you really believe that either side, at this point, cares that much about the best interests of the shareholders, the company’s future or the employees? For the most part, they are in it for the money or the ego! I am not trying to be judgmental about it, that’s just the way it is. If you profit along with them, that’s fine. If not, oh well, too bad.

So now that we know that Icahn wants to make money, how can he do it? What does he want to do to reach his goal of maximizing his return on this deal?

Icahn’s best option: Force Yahoo to go back and work out a deal with Microsoft, even if it is at $33 a share.

The easiest way is for Icahn to profit on his investment would be to go to Microsoft and try to negotiate a handshake deal before the proxy fight. Icahn could make a call and say, “Steve, I know you were interested. If I bring it to you at 34, can we do it?” Some journalists have suggested this may have already happened. I am telling you that it probably didn’t happen, at least not directly from Icahn. Icahn is a smart and shrewd guy, and he knows any initial or substantial contact with Microsoft would show weakness, and he simply won’t do it. To cut any kind of deal with Microsoft, he will need options, and that approach doesn’t give him as many.

That is not to say he doesn’t want the Yahoo Board to do it. So Icahn’s first and best option relies on applying enough pressure to Jerry Yang and the Board to force them to open up negotiations with Microsoft. The key thing to remember in threatened takeovers - fear is the motivator, not necessarily action. Once you have acted, you set things in motion requiring a target to respond. Once they respond and start fighting, they are no longer as afraid of the fight.

Negotiating a deal with Microsoft now however does not look to likely at this point. First, the Board and Jerry Yang seem to be united in their position now. In Roy Bostock’s letter to Carl Icahn, he chastises him for not “understanding” either Yahoo’s business or the fact that Microsoft has “moved on.” That letter alone is a “call to arms” for Icahn.

In addition, why would Microsoft come back so soon, when they can wait? They have already established an approximate maximum value on Yahoo at $33 or maybe $34 a share. Yahoo was at best heading for a flat year based on their first quarter results (see Analyzing Yahoo's First Quarter Results - Conference Call 101 ). If Yahoo executives and employees engage in a long proxy fight, Yahoos’ results will likely suffer further in a stagnant economy, allowing Microsoft to buy later at a better price and on better terms. Steve Ballmer may look like a hero to the employees in two or three months.

For Steve Ballmer to come back and agree to $33 or $34 would also be an acknowledgeent by Steve that Carl Icahn can accomplish something – acquiring Yahoo without a fight – that Ballmer was incapable of doing.

I just don’t see a friendly deal between Yahoo and Microsoft happening now.

Icahn’s Second Option: Engaging in a Proxy Fight to Unseat the Board – then Selling to Microsoft

Based on some “back of the envelope” calculations, I estimate that Icahn has made roughly $150-$200 million on his Yahoo positions. If he engages in a proxy fight and loses, he could see that gain evaporate. If he buys more shares, wins a proxy fight and sells the company, he stands to gain another $500-$700 million.

The smart strategy would be to use this weekend garnering shareholder support for his total slate of candidates. He may, however, also be asking those who do not support the entire slate to at least support the key Icahn candidates for partial Board representation.

Why? Because that is the smart thing to do, and Icahn is a smart guy. The more support he obtains for any Board representation helps him convince other shareholders to support full Board representation. In addition, some shareholders may be concerned that the new Board does not have the experience to run an internet company or that replacing the entire Board may have negative implications with key employees. More importantly, Icahn cannot afford to lose this proxy fight in its entirety, and watch his gains evaporate. Remember, one of Icahn’s key takeover philosophies, which he espoused in his interview with 60 Minutes – some years you make 70%, some years you make 7%, but the key is not to lose money.

We should know in the next week or two whether Icahn will have the necessary support. He will be looking for public support from Gordie Crawford of Capital Re and Bill Miller from Legg Mason, who both have criticized Jerry Yang and the board for the handling of the Microsoft offer. If Icahn gets their public support, he can put additional pressure on the Board.

Crawford and Miller will therefore probably initially support Icahn’s actions because they support the theory of trying to reopen negotiations with Microsoft. With that support, Icahn and the supporting shareholders will demand that the Board contact Microsoft. Now they can make back door contacts with Microsoft.

What would be Microsoft’s response? It should be, “We’ve moved on.” You see, Microsoft knows a few important facts. Jerry Yang is more than willing to lose money on his shares or arguably sabotage the company’s future to keep his company independent. That is why Microsoft walked away. They can’t afford to do an unfriendly deal; they can’t afford to trust Jerry. So they play both sides against each other. They tell Icahn that they have moved on, but would surely talk to them once they get control of the Board. They tell Yahoo, if asked, that they have moved on, and even if they were interested, they have decided it doesn’t make sense at $33 a share.

Microsoft will say they moved on, but will provide just enough “ambiguity” to ensure that Icahn is successful in getting Board representation. This strategy by Microsoft ensures one of their two goals – either acquiring Yahoo for a good price or ensuring that Yahoo becomes a much weaker competitor (see Yahoo Shouldn't Have Rejected Microsoft's Offer).

Icahn’s Third Option: Board Representation

Now that Icahn achieves some level of Board representation, what will happen? Icahn will claim victory and the Board will have some serious discussions about increasing shareholder value, starting with Microsoft.

Before we decide how Microsoft will respond, let’s look at the new Icahn Board’s other standard options:

1. Invest more money in Yahoo, insert Mark Cuban as CEO and move forward to challenge Google? Ok, it’s funny. Mark does however know when to sell.
2. Find another buyer to compete with Microsoft? And just who would that be at $46 Billion? Hey, maybe Time Warner (TWX) wants to take another shot with an Internet company? No, probably not. Sell to Apple? Hey Steve Jobs is a lot of things, but he’s not stupid – he’s driving a Mercedes, why would he want a Chevy.
3. Break up the company and sell the assets? What assets? Maybe they could sell Yahoo’s Asian assets, but who is going to buy them? Aren’t those assets worth more in the future if they are integrated with Yahoo? Maybe Google would want them – but would there be any US or foreign antitrust concerns? Maybe Microsoft would want them, but they probably wouldn’t buy them separately. So say the Board can sell them to overseas investors or someone at $12 Billion. Is the rest of Yahoo worth $32 billion? Answer – No.
4. Let current management continue in their attempts to turnaround the company? I don’t think Icahn would go through the trouble to engage in the proxy fight to allow current management to continue. He could sell now and just keep his profit.
5. Hire new management and drastically cut expenses? This is the most likely scenario, absent a sale to Microsoft. However, is Icahn willing to wait for returns on his money? With new management, it would take at least 12 months to turn the company around. What happens to the stock price during this time? What do you think Google and Microsoft are going to be doing during this time? This may be the right solution for Jerry Yang, but not for Icahn. What happens to employee morale – some of them may not like Jerry, but do you think they will like Icahn better?

Oh, ok, so that leaves Microsoft. It isn’t often that the Black Knight also gets to be the White Knight. If Microsoft is still interested, do they still pay $33 a share? Not likely. At that point, even if it did agree to $31 a share, the agreement would likely include more stock and much less cash, with the share price contingent on employee retention and hitting certain earnings milestones. There is another benefit to Microsoft of doing the deal after Icahn obtains Board representation - it likely will have much greater support from the employees at that time, maybe even Jerry.

So What Do You Do if You Are a Stockholder?

The stock is being supported by two related conditions – the possibility of a buyout by Microsoft and the possibility of Icahn getting Board representation to force the possibility of a buyout by Microsoft. The stock should drift higher as Icahn garners shareholder support, and as he obtains any kind of Board representation.

At any time between now and the actual shareholder meeting, if the stock gets close to $30, you should sell it. Why? Because whatever upside remains, it’s too risky to justify holding the stock. If Microsoft agrees to buy Yahoo, even for $33, you still have deal contingencies that could make the effective price lower. It also may take a year to get regulatory approval and get the deal done. If Microsoft walks, what happens to the stock? Well, it’s not going to go up. You can bet Icahn will protect his position; likely with options before a deal gets done.

So What Should Jerry Do Now?

Jerry should fulfill his responsibility as a fiduciary to shareholders by negotiating in good faith with Microsoft and accepting a fair price for the company. Oh yea, I forgot, he already turned that idea down.

So now Jerry is in a potential mess. Ballmer doesn’t like him, Icahn doesn’t like him, Gordie Crawford doesn’t like him, and Bill Miller doesn’t like him.

What can he do to make everyone go away and let him run his company? Well, since Microsoft is really everyone’s’ only option, how can he take away that option? At the same time, how can he make the existing management of the company so complicated that Icahn won’t want to be on the Board?

That’s easy. Just play chicken. What? Play Chicken?

Yes, do the very thing that prevents Microsoft from buying you and also simultaneously stops Icahn from wanting to seek Board representation in the absence of a potential Microsoft offer.

Call Time Warner! You see they already don’t like Icahn, a lot. And they want to really get rid of AOL – don’t let them fool you with all their talk of specialty sites and niche focus. They want to sell.

Sometimes the enemy of your enemy is your friend. Strike a great deal with them to acquire AOL, and obtain some investment cash from them. As part of the deal, try to negotiate a better price or better terms by using your Asian assets as a guarantee.

Microsoft can’t buy you because of antitrust concerns. You tie up your Asian assets so they can’t be sold without Time Warner’s approval. Isn’t that a funny twist for Time Warner and Icahn?

Sure your stock will fall, but who does that hurt? Sure it hurts your shareholders, but that didn’t bother you before. But it will scare the hell out of Icahn. Without any real alternative to sell to Microsoft, what is he going to do? Manage or oversee the integration of Yahoo and AOL? Yea right! His best option would be to liquidate his positions and avoid any losses – remember he said the key thing to remember is not to lose money.

AOL and Yahoo can kill two birds with one stone – get rid of the albatross around their neck and get rid of the vulture above yours So play Chicken and maybe you can beat Icahn.

Ready – I think Icahn, I think Icahn, I know Icahn.

Disclosure: None

Comments

[GyZmOjO:]

good one, tsun tzu!!!

2008 May 19 11:06 AM

[mrhockey123:]

good read, Tim.
As you point out, I would be pretty shocked if stuck with 33 or 31.

As I've been saying for the last few days, you'd get a "bride price" if you go to the alter willingly, but if you turn it into a shotgun wedding, you take what you can get - unless you want a bullet to the brain!

the one thing I like about Ichan (and the thing that Yang should like) is that Ichan has basically come and offered to play "bad cop"

It's like "miracle on ice" where the USA's coach pretty much decided to be completely harsh to the entire team so they all united to hate him...but they used that motivation to win.

My point is, if Ichan plays bad cop, Ballmer doesn't have to. Ballmer would tick off all the Yahoo employees who might bolt. With iChan, both sides come out innocent, Ichan takes the blame (he's not one to garner a reputation as a cuddly teddy bear so he doesn't care) and we end up maximizing yahoo shareholder value, and Microsoft gets what it originally wanted.

2008 May 19 11:36 AM