Update: Clash of the titans: Yahoo's fate in the balance

Yahoo to review its options; Microsoft still viewed as winner

The fray over Microsoft Corp.'s unsolicited $42 billion takeover bid for Yahoo Inc. took a strange turn this week, and analysts are divided on what the new developments mean for the two companies.

The Wall Street Journal reported yesterday that Yahoo is in talks with Time Warner Inc. to combine its Internet operations with AOL LLC in an effort to thwart Microsoft's bid. At the same time, News Corp., owned by Rupert Murdoch, is in talks with Microsoft to jointly bid for Yahoo.

Yahoo is trying to fend off a takeover bid by Microsoft or, at least, to get Microsoft to raise its offer. Microsoft, which wants to acquire Yahoo to gain a stronger foothold in the online advertising market, hasn't raised its offer. However, if it took on a partner, such as News Corp., it might be willing to pay more, analysts said.

AOL, News Corp. and Microsoft declined to comment, and Yahoo could not be reached for comment.

Meanwhile, Yahoo's board is scheduled to meet today to assess its alternatives to a Microsoft takeover, the Journal reported Friday. The board will discuss Microsoft's offer and Time Warner's plan to fold AOL into Yahoo in exchange for a 20% stake in the company. A third option is a joint deal between Microsoft and News Corp., whereby a new company would be formed combining Yahoo with News Corp.'s MySpace and Microsoft's MSN, the Journal reported, citing unidentified sources.

"The stakes for this Yahoo acquisition are absolutely monumental," said Dana Gardner, an analyst at Interarbor Solutions LLC in Gilford, N.H. "This is a very big deal for Microsoft and also for Google, and if Google can't acquire Yahoo because of antitrust concerns, which is the general consensus, there would have to be some kind of a wacky partnership -- a cabal of participants -- in order to thwart Microsoft."

"Then Microsoft turns around and says, 'Oh yeah, we have friends, too,'" Gardner continued. "So we have what basically amounts to the Jets and the Sharks, a couple of gangs from the West Side of New York bulking up in order to see who's going to win. This is like gang warfare."

Gardner said the only deal that has legs is the potential matchup between Time Warner and Yahoo. But first, Yahoo has to make up its mind about what kind of a company it wants to be -- a media company or a software company, he said.

"Time Warner is among the biggest of the world's media companies, and if Yahoo partners with Time Warner, then Yahoo is a software company, and Time Warner becomes the content media company and they could make happy music together," Gardner said. "If Yahoo combines with Microsoft, then its software becomes subsumed into Microsoft, and Yahoo becomes really just a brand-media content overlay on top of the Microsoft empire."

Gardner said Yahoo would probably prefer a matchup with Time Warner, which would need its software capabilities in order to be competitive.

He added that it will be interesting to see if Yahoo and Google Inc. decide to extend a test announced yesterday whereby Yahoo delivers Web advertising from Google alongside its own search results. If the two companies expand their partnership, then the triumvirate of Time Warner, Yahoo and Google would be a "pretty powerful entity," he said.

Google could not be reached for comment.

So, while Yahoo shareholders want to get as much money as they can from a Microsoft acquisition, that choice might not be in the best interests of the company in the long term, Gardner said.

In addition, a Yahoo-AOL deal is unlikely to present the kinds of antitrust concerns with the U.S. Department of Justice and the Federal Trade Commission that some of the other ventures may because Yahoo and AOL are not the dominant players in any market, said Marc Edelman, a law professor at New York Law School and a former antitrust attorney.

However, Edelman said, AOL and Yahoo are struggling in certain sectors, and putting together two struggling companies may end up having less value for investors.

As for Microsoft and News Corp. putting in a joint bid for Yahoo, Edelman said it's an "unusual circumstance" when two separate companies get together to do anything.

Both Microsoft and News Corp. have investments in major social networking sites and the role of those sites needs to be addressed first, Edelman said. Microsoft owns a stake in Facebook Inc., and News Corp. owns MySpace.com, which are the dominant properties in the emerging social networking market, he said. "So the first question is, before we even get to Yahoo, what could the relationship be between News Corp. and Microsoft?" Edelman noted.

Edelman said if those two big players get involved in anything together, there would have to be some sort of firewalling between Microsoft and News Corp. to prevent the exchange of sensitive information between employees working on Facebook and employees working on MySpace.

Meanwhile, if AOL were to be folded into Yahoo, the company might have less return on investment because AOL's fortunes have been shakier over the past several years, Edelman said, but such a deal would have a good chance of being approved by government regulators.

Rob Enderle, an analyst at San Jose-based Enderle Group, said if Yahoo and AOL can make a deal work, it will potentially make Yahoo more valuable and could force Microsoft to increase its bid.

"Also, with Time Warner behind it, if Yahoo wants to resist the acquisition by Microsoft, it gives them a bigger bully to help them do that," Enderle said. "Remember that Time Warner has wanted to divest AOL for some time, so my guess is that this is a ploy to get Microsoft to buy both properties and to do so at a premium because they're worth more together than they are separately. That would allow Time Warner to step away from AOL, and it would allow Yahoo to get a price that is closer to what it is they're looking for."

Microsoft would get ownership of all four of the major instant messaging products, none of which can operate with any of the others. Enderle said that piece of the deal would most likely not incur the wrath of regulators because consumers have been clamoring for interoperability among the various services. In addition, he said, because the services are all free, there would be no reason to worry about price-fixing.

Enderle also said a combination of News Corp.'s MySpace and Microsoft's stake in Facebook would present a credible hedge against Google.

"With Yahoo alone, I think there was a question about whether it was tough enough, but you throw in MySpace on top of that, and with the potential of AOL, and suddenly you've got enough core power to credibly go up against Google," he said. However, he said that such a complex arrangement would be hard to do and that he doubted whether it would be possible to get so many players at the table to agree to anything. But, he added, "the potential is significant."

"Silicon Alley Insider" founder Henry Blodget said on the site that while a Microsoft-News Corp. alliance could go after Yahoo, it wasn't a smart move.

He questioned why Microsoft, "one of the richest companies on Earth, with a $300 billion market cap," would need to partner with anyone to raise its bid for Yahoo. He added that Microsoft could jack up its Yahoo offer by 50% and "barely feel it."

"Whatever cash Murdoch can bring to the table is gravy, not meat," Blodget said.

Despite all the reports of combined companies, Citigroup Investment Research analyst Mark Mahaney said the most likely outcome is still a Microsoft acquisition of Yahoo.

"And [we] continue to believe that it will happen at a higher price than the initial $31 [per share] bid," he said in a research note. "A combined News Corp.-Microsoft bid very likely means a higher bid for Yahoo. An AOL-Yahoo strategic deal that involves the repurchase of Yahoo shares at a higher price than $31 very likely forces a higher bid for Yahoo. And a full Google Search outsource deal -- with over $1 billion in accretive cash flow -- almost certainly forces a higher bid."

Copyright © 2008 IDG Communications, Inc.

  
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