Sizing up Microsoft and Yahoo: Did anybody win?

Microsoft did the smart thing, while Yahoo needs to act fast or face shareholder wrath, analysts say

Now that Microsoft Corp. has dropped its bid to take over Yahoo Inc., industry analysts assessed what happened and what to expect from the two companies.

Microsoft gave up its effort to acquire Yahoo because the software company decided it wasn't worth the cost and potential negative publicity involved with a proxy fight, said Marc Edelman, a law professor at New York Law School and a former antitrust lawyer, in an e-mail. Either that, or Microsoft figured it couldn't win in a proxy fight, he said.

In the coming weeks, however, Edelman said it's likely that Microsoft will increase the pressure on the U.S. Department of Justice to investigate the proposed advertising joint venture between Yahoo and Google Inc.

"If the DOJ does not act vigilantly, I would not be shocked to see Microsoft file a suit itself," he said.

Microsoft strategy didn't work

Rob Enderle, principle analyst at Enderle Group in San Jose, said Microsoft's initial strategy was to overbid its offer so the company could close the deal with Yahoo quickly. (Microsoft on Feb. 1 offered $44.6 billion in cash and stock, a 62% premium over Yahoo's closing price at the time.) However, Enderle noted, Microsoft didn't leave Yahoo's board with an option that allowed it to exit the process looking like it had negotiated strongly.

"The end result was that the two sides couldn't come together," Enderle said in an e-mail. "Given what we know of Google and its ability to manipulate situations that favor it, it wouldn't surprise me if [Google] had something to do with how badly this went. However, Google wanted the two firms focused on each other and not on Google, [but] Microsoft's exit ends that." Meanwhile, Enderle said, Yahoo now has a serious problem because the company's shares could tank, and angry shareholders may pursue a lawsuit.

"[Yahoo] will need to come up with a plan quickly to increase the perception of value for the firm and to take the pressure off the executive staff and board," he said. "The board is up for election, and this won't bode well for them."

Conversely, Microsoft will most likely be rewarded for walking away from the acquisition because the market didn't like the deal, Enderle said.

"Microsoft couldn't really afford the distraction of a merger anyway, and its financials reflect that," he said. "In addition, the merger attempt opened up opportunities with News Corp. and Time Warner Inc. that may have not existed before and may actually turn out to be both less risky and, in the end, more lucrative than [a deal with] Yahoo would have been. We'll see, but I expect Microsoft will be spending some time looking into what Google was doing while it was distracted."

Because Microsoft was unable to persuade Yahoo's leadership to accept its final offer, Microsoft's leaders decided that pursuing a hostile takeover was not in the company's best interest, said Andrew Frank, an analyst at Gartner Inc. in Stamford, Conn.

Quick action needed from Yahoo

"Yahoo must now demonstrate to its shareholders that its directors' insistence that the offer undervalued the company was justified," he said in an e-mail. "Meeting this challenge will require bold steps, both in continuing to innovate its own platforms, and cultivating new partnerships and acquisitions that can have a significant near-term impact on Yahoo's performance and perceived value."

Henry Blodget, CEO and editor in chief of the "Silicon Alley Insider" business news Web site, also predicted that Yahoo's stock will drop and that Microsoft's will rise in the aftermath of Microsoft's decision to yank its offer.

"We think Yahoo is taking a big risk not accepting $33 [per share], especially if the offer was cash, and we imagine Yahoo shareholder frustration will be intense," Blodget said in his blog. "We hope Yahoo continues to pursue its search outsourcing deal with Google, as well as its discussions with Time Warner over AOL LLC. We suspect Microsoft might immediately emerge as a counterbidder for AOL."

Blodget said Microsoft made the right decision for a number of reasons, including the fact that he thinks combining the two companies as proposed would have been a "disaster"; Microsoft really didn't need to be in the same business as Yahoo; $37 per share was too much for Microsoft to pay at this point; and if Yahoo doesn't come up with a solid plan, Microsoft might be able to buy it for less than $30 per share in six months to a year.

In addition, Blodget said Yahoo should continue its outsourcing deal with Google. "Yahoo's search partnership with Google played a major role in allowing the company to fight off Microsoft," he said in his blog. "By offering the hope of immediately higher cash flow, it should also stop Yahoo's stock price from falling back to the teens."

Dana Gardner, principal analyst at Interarbor Solutions LLC in Gilford, N.H., is not sure a Yahoo-Google partnership is in Yahoo's best interests.

Yahoo will not have long to prove it can go it alone, or it will be poached by any number of companies, including Microsoft, Gardner said in an e-mail.

Yahoo has to practically reinvent itself as a culture and become urgent about being a stand-alone Internet company but with the best partners for content, ads, media and communications, he said.

"Yahoo needs to create a cloud computing value that helps it compete against Google," Gardner said. "If Yahoo gets too close to Google, it will diminish in importance over time."

The clock is also ticking on Microsoft, he added.

"[Microsoft] needs to become No. 1 or No. 2 in online consumer and business 'something' before its Office and desktop Windows franchises go into slow growth and/or maintenance mode," Gardner said. "Microsoft also needs to become a better partner to media companies and to develop the technology and cloud computing [to compete] with Google on more kinds of services, even if it cannot close the gap on search."

Copyright © 2008 IDG Communications, Inc.

  
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