Yahoo's forcing Microsoft to play hardball

February 11, 2008: 11:06 AM ET
Yahoo headquarters
Yahoo's board of directors has spurned Microsoft's takeover bid, calling it too low. Courtesy of Yahoo.
Yahoo 1-month
Yahoo stock spiked after Microsoft's bid, reclaiming levels it last saw in November when investors were more optimistic.

Yahoo's (YHOO) board of directors unanimously rejected Microsoft's (MSFT) marriage proposal as too cheap, a bold move that could force Microsoft to instigate a shareholder revolt in order to get its prize.

In a press release Monday morning, Yahoo said Microsoft's offer of more than $40 billion "substantially undervalues" Yahoo's brand, audience, investments and potential. On Wall Street, Yahoo's stock started the week up about 2 percent and Microsoft down nearly 2 percent, suggesting that investors believe Microsoft will have to sweeten its offer.

Microsoft responded on Monday afternoon with a statement calling it "unfortunate" that Yahoo turned down its proposal, and saying that Microsoft "reserves the right to pursue all necessary steps" to ensure that shareholders get the opportunity to have their say.

Though Yahoo is playing hard to get, Microsoft has positioned the takeover as the only way either company can compete with a rapidly ascendant Google (GOOG). Google has such a dominant share of search engine customers that other companies can't create a strong alternative, and advertisers have no choice but to spend most of their money with Google. Microsoft believes that by purchasing Yahoo, the number-two search provider and one of the most popular online destinations, it can quickly turn itself into a serious contender.

And the software giant has offered to pay dearly for that new status. Microsoft's offer of more than $40 billion is not only the largest bid it has ever made for a company, it is the only unsolicited takeover it has ever attempted. Microsoft plans to finance half of the transaction with cash and half with stock, and to take on debt in the process.

So far, Yahoo is not making it easy. To overcome Yahoo's defiance, Microsoft might have to install new leadership at the Internet giant. That would mean nominating a new slate of directors to be elected at Yahoo's annual meeting this summer. Directors friendly to Microsoft's bid could then move the process forward.

Indeed, the hostile offer Microsoft unveiled 10 days ago is timed perfectly to win over an unwilling target. According to Yahoo's bylaws, Microsoft can signal its intent to nominate new directors at any time between February 13 and March 14, about three months before Yahoo's annual meeting.

Sources familiar with Microsoft's thinking last week gave no indication that the company expected a unanimous rejection from Yahoo to come so quickly. They suggested that while senior Yahoo managers such as co-founder and CEO Jerry Yang weren't open to a deal, Yahoo directors would be far more receptive. So the Yahoo board's Monday announcement, which presented a united opposition to Microsoft's bid, could force Microsoft to alter the way it talks about its takeover strategy.

But Microsoft also seemed ready to begin publicly soliciting Yahoo shareholders through a tender offer. A source with knowledge of Microsoft's legal strategy pointed out that once Microsoft makes such an offer, antitrust regulators can begin reviewing the deal. Microsoft would be eager for that process to begin, since it could easily take 6-9 months and the company has said it hopes to have swallowed Yahoo by the end of 2008.

Yahoo's statement:

YAHOO! BOARD OF DIRECTORS SAYS MICROSOFT'S PROPOSAL

SUBSTANTIALLY UNDERVALUES YAHOO!

Sunnyvale, Calif., February 11, 2008 — Yahoo! Inc. (Nasdaq: YHOO), a leading global Internet company, today said the Yahoo! Board of Directors has carefully reviewed Microsoft's unsolicited proposal with Yahoo!'s management team and financial and legal advisors and has unanimously concluded that the proposal is not in the best interests of Yahoo! and our stockholders.

After careful evaluation, the Board believes that Microsoft's proposal substantially undervalues Yahoo! including our global brand, large worldwide audience, significant recent investments in advertising platforms and future growth prospects, free cash flow and earnings potential, as well as our substantial unconsolidated investments. The Board of Directors is continually evaluating all of its strategic options in the context of the rapidly evolving industry environment and we remain committed to pursuing initiatives that maximize value for all stockholders.

Goldman, Sachs & Co., Lehman Brothers and Moelis & Company are acting as financial advisors to Yahoo!. Skadden, Arps, Slate, Meagher & Flom LLP is acting as legal advisor to Yahoo!, and Munger Tolles & Olson LLP is acting as counsel to the outside directors of Yahoo!.

Microsoft's response:

It is unfortunate that Yahoo! has not embraced our full and fair proposal to combine our companies. Based on conversations with stakeholders of both companies, we are confident that moving forward promptly to consummate a transaction is in the best interests of all parties.

We are offering shareholders superior value and the opportunity to participate in the upside of the combined company. The combination also offers an increasingly exciting set of solutions for consumers, publishers and advertisers while becoming better positioned to compete in the online services market.

A Microsoft-Yahoo! combination will create a more effective company that would provide greater value and service to our customers. Furthermore, the combination will create a more competitive marketplace by establishing a compelling number two competitor for Internet search and online advertising.

The Yahoo! response does not change our belief in the strategic and financial merits of our proposal. As we have said previously, Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo!'s shareholders are provided with the opportunity to realize the value inherent in our proposal.

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