Why Ballmer Bailed on Yahoo

According to consultant Jeffrey F. Rayport, there are five reasons Microsoft's chief gave up on his bid for Yahoo, including its cost and its not making sense

By Jeffrey F. Rayport

Microsoft CEO Steven Ballmer. David Hecker/AFP/Getty Images

It's not every day a titan of industry eats humble pie—at least not in public. But Steve Ballmer, Microsoft's CEO, did just that this week, climbing down from his $45 billion bid to acquire Yahoo!.

When Microsoft (MSFT) announced the deal in February, Ballmer hailed it as "the next major milestone in our companywide transformation to embrace online services, search, and advertising." With global online ad revenue projected to double to $80 billion by 2010 from last year's $40 billion, he wanted a bigger piece of the pie. The key was to bag Yahoo (YHOO), the once-celebrated Internet pioneer, still a top-three Web destination, and the No. 2 player in search after Google (GOOG).

So why did Ballmer have a change of heart about the deal? Let's try five reasons, outlined as follows.

It Wasn't Quick

If Ballmer thought he would be greeted as a "liberator" in acquiring Yahoo, he was as misguided as the Bush Administration was about Iraq. Jerry Yang, CEO of Yahoo, wasn't just coy in response; he openly repudiated the offer, and his board backed him up. In claiming that Microsoft's bid dramatically undervalued the company—despite a 70% premium over Yahoo's pre-bid $19 share price—Yang made it clear that a protracted negotiation was only the least awful among many unattractive possibilities, including a proxy fight, a hostile tender offer, and an embarrassing implosion of the deal.

Then, when Yang and his president, Sue Decker, hit the road in March with a business plan designed to demonstrate the outsize value Yahoo could create for shareholders (forecasting a quasi-miraculous doubling of cash flow over the next three years), it was evident Ballmer had found his quagmire, and he was in for the long slog.

It Wasn't Easy

Ballmer prophesied that joining forces would yield a bounty of synergies: bringing two of the four highest-traffic Web portals under one roof; more plentiful engineering talent; enhancements in online services; and, of course, the elimination of redundant operations and staff. It sounded good—to the tune of a billion dollars in up-front cost savings. But then reality reared its ugly head. Antitrust considerations made it unlikely the combined company could unite the world's two top e-mail services—Yahoo! Mail and MSN's Hotmail—with half a billion users between them (as compared with 90 million for Google and 50 million for Time Warner's (TWX) AOL). Ditto for instant messaging: The merged entity would control as much as 90% of that market.

These issues paled in comparison with the lack of cultural fit between the two players. Many Yahoo employees regarded Microsoft as the enemy. And, like a homeowner threatened with foreclosure, Yang signaled he was prepared to damage the company rather than yield to the so-called evil empire. This included striking a preliminary deal with Google to deliver ads for Yahoo's search results, essentially installing an archrival's Trojan horse in the Yahoo boardroom.

It Wasn't Fun

When Yahoo rebuffed Microsoft's opening bid, Ballmer huffed and puffed. He openly scorned the "deteriorating" performance of Yahoo's business, only to see his prey perform above expectations in the first quarter. He threatened to "go hostile," as they say, but Yahoo's board yawned over his menacing imprecations. Yet none of this compared with the scorn he encountered among his own Microsofties, who saw the offer as yet another chapter in the continuing saga of overpriced acquisitions, sluggish innovation (Zune anyone?), and ineffective online strategies.