Markets & Finance

Marcial: Yahoo's Endgame


Negotiations with Microsoft and Google are taking place behind the scenes, writes BW's Gene Marcial. A deal of some kind is imminent, according to his sources

Yahoo! finally looks ready to do a deal, according to people familiar with the situation. Pressure from large shareholders has persuaded Yahoo to work out a transaction with Microsoft, or alternatively, with Google. "Something will definitely happen soon" says one of the people involved in solving Yahoo's conundrum.

"As it now stands, Microsoft is no longer expected to meet fierce opposition from Yahoo's top decision makers on its initial bid to buy Yahoo, albeit at a price slightly better than its initial offer of $44 billion, or $31 a share, on Jan. 31," says one of the people acquainted with the behind-the-scenes negotiations involving Yahoo (YHOO), Microsoft (MSFT), and Google (GOOG). Microsoft abruptly backed out of talks with Yahoo on May 3, after withdrawing its latest offer of $33 a share, or $47.5 billion.

Search-ad plans

Sources familiar with the situation say that Microsoft is still very interested in buying Yahoo outright. Spokespersons for Yahoo and Microsoft declined to comment on any negotiations. Several big shareholders are in on the talks. Microsoft said on May 18 that it is talking with Yahoo about a "transaction" that would be short of a full buyout, which sources say involves a purchase of Yahoo's search-ad operation.

But if Microsoft and Yahoo can't agree on a full buyout, Yahoo is prepared to go ahead with an alternative deal with Google that is also favored by some of the big investors: a nonexclusive outsourcing partnership on Yahoo's search-ad business. As described by one of the people involved in the talks, Yahoo is expected to save close to $1 billion in costs and, at the same time, increase revenues from search ads.

Other sources close to the situation describe a possible Google deal differently. They say the search giant would participate in an open auction for Yahoo's search ads, the proceeds of which could be worth hundreds of millions for Yahoo. But the deal would not involve all of Yahoo's search ads, they say, and Yahoo would retain much of its search and search-ad infrastructure, lessening its savings.

Icahn effect

Among the big shareholders that are said to have applied heavy pressure on Yahoo to work out a deal are Robert Lovelace, chairman of Capital Research Global Investors, which owns a nearly 10% stake; Carl Icahn, who owns a 4.3% stake; hedge fund Paulson & Co., with 3.6%; T. Boone Pickens, who recently purchased 0.73%; and Steven Cohen's S.A.C. Capital Advisors, with 0.6%. "There has been a lot of headway in talks about a deal because of strong pressure from some of the large stakeholders," according to a source familiar with the situation. They declined comment.

Since Icahn announced his purchase of Yahoo shares on May 15, at an average price of $25 to $26 a share, the stock has climbed to more than $27. Icahn has threatened to wage a proxy fight to oust board members and formed a slate of 10 nominees of his own to replace them. Yahoo has delayed its annual meeting from July 3 to the end of July.

"We believe the push-back of the meeting will allow Yahoo to continue negotiations related to potential corporate transactions, and possibly preempt or minimize unpleasant developments that could come to a head at the meeting," says Scott Kessler of Standard & Poor's. Kessler has a price target of $33, which he explains is "equal to the last proposed offer Microsoft made to acquire the company, and the amount on which Carl Icahn indicated he is focused on." He believes Microsoft continues to be interested in acquiring Yahoo and that Icahn will ultimately be successful in bringing the parties together and helping consummate a deal.

Second time is the charm

Mark May of investment firm Needham upgraded Yahoo to buy from hold, based on his belief that "significant positive change is more likely to happen at Yahoo" because of actions and statements by Icahn, Microsoft, Yahoo, and others over the past few days. "We believe a Microsoft acquisition is the most likely outcome, with an assumed 50% probability of an acquisition, either at $33, $35, or $37 per share," says May. In Needham's analysis, "we give greater weight to a compromise price," he adds.

The second most likely outcome, according to May, is a search-outsourcing agreement with Google, Microsoft, or both. But he believes that an outsourcing-search agreement would be the "wrong long-term strategic move for Yahoo."

From how it looks right now, Icahn may not get the chance to wage a proxy fight. Although a deal is never a deal unless it is formally approved and signed by all the parties concerned, it appears that Microsoft is closer to buying Yahoo than at any time since it first made its unsolicited buyout bid in January. Meanwhile, Google is anxiously waiting in the wings, still hoping it can get a slice of Yahoo's search-ad business.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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