I think we all knew it would come to this one day. Microsoft, the world’s largest software company, has made an offer to buy Yahoo, formerly the largest trafficked company on the internet. Microsoft’s offer is to buy the company outright, either in cash or stock, for $44.6 billion, offering $31 per share of Yahoo, a 62% permium over the share price when the offer was made.
Yahoo’s misfortunes are well known. The company, with a rich portfolio of internet properties, bet against web search and outsourced its search engine, licensing technology from a little company called Google. Eventually, web search became the driving force in how users navigate the internet, and users decided to go straight to Google, instead of accessing it through Yahoo.
Yahoo had a chance to buy Google, first for a billion dollars, later for a few billion, but the offer was always slightly less than what the search company thought it was worth. Eventually, it was too late, and Yahoo realized it needed to build its own search engine. Yahoo’s search engine was a long, costly effort, including a $2 billion acquisition of Inktomi, and by the time it hit the market, users had left for Google-y pastures. Yahoo’s effort, while good enough, was too slow and too late.
A little company called Overture invented a means for combining search and advertising, with auction-based keyword targeted text ads. Yahoo bought Overture, then proceeded to sue Google, whice made sense: Google had completely ripped off Overture’s concept, and was liable for every dollar it earned using that form of advertising.
Rather than aggressively fight the small search company, which was clearly infringing on Yahoo-owned patents with every dollar it earned, Yahoo settled, agreeing to take 2.7 million shares of Google, just over 1% of the company (at the time). Yahoo sold those shares as soon as Google went public, for $82.62 a share, or $223 million.
In November, Yahoo could have sold those shares for $2.017 billion. However, the bad investment is not the real story. Yesterday, Google announced revenues of $4.8 billion for the quarter, or $16.6 billion for the last 12 months. All but less than 1% of those revenue are earned on the back of a patent Yahoo still owns to this day, but Yahoo gave up the rights to sue for those $16 billion for just $223 million. When the opportunity was there, Yahoo was not aggressive and did not go for the kill.
Instead, Yahoo began developing an alternative ad technology, combining Overture with its own systems, in order to provide greater value to the advertiser. Yahoo had more traffic than Google, though at this point, less search traffic, and if its new project, code-named Panama, could bring in more money for that traffic and more happy advertisers, Yahoo would be strong and healthy for the next round, in which it would hopefully do better.
That plan failed. Project Panama was plagued by delays, and by the time it finally made it to market, the damage had already been done and Google was a $100 billion company. Panama’s benefits took too long to materialize and after years of waiting for them and letting Google take over the market, there wasn’t enough valuable search traffic or enough of an advertiser community for Yahoo to save itself. Yahoo’s effort, while good, was too slow and too late.
Last year, Yahoo fired Terry Semel, the CEO who made most of these bad decisions. Yahoo installed Jerry Yang, founder of the company, as the new CEO, and began grooming Sue Decker to eventually run the company. Yahoo has now had seven months to turn the company around, but it has made no aggressive moves, built no investor confidence. Now, Yang can oversee the sale of the company he created.
Yahoo may not choose to accept the offer, but it is a good one. The company’s shares were trading at $19.18 last night, a market cap of $25.6 billion. Microsoft’s offer represent a huge premium over the stock value of the company, over $18 billion higher, and is aggressive enough that, if Yahoo’s board says no, could be a very successful hostile takeover. Yahoo may have no choice.
What about antitrust regulators? Won’t they be concerned? After all, Microsoft’s antitrust agreement with the U.S. government was just extended. No, or at least not likely, because Microsoft’s antitrust agreemeng covers operating systems, not internet properties. However, there could be concern in some areas that Microsoft is amassing too much market share.
Microsoft and Yahoo’s email properties are strong, numbers one and two in the market. Their instant messenger products are also among the most used. An argument could be made that the two should not be allowed to combine, but it is likely a failing argument, due to the strength of competitors, like Gmail and AOL Instant Messenger.
What would a combined company have?
- About 30% of the search engine marketplace. Microsoft has wanted a position to challenge Google for a long time, and this would give them a big enough search engine to hopefully make some noise. However, Microsoft would have to reverse Yahoo’s decline in order to take advantage of that market share.
- Yahoo Mail and Windows Live Hotmail. Yahoo claims 255 million email account, Microsoft 280 million. Reports put Gmail at around 51 million accounts. If properly leveraged, Microsoft’s 500 million-plus accounts could represent an insurmountable number one.
- Yahoo Messenger and Windows Live Messenger. As of 2006, Microsoft had 61% market share worldwide, good for #1, and Yahoo had between 27% and 37%. Yahoo’s number were the same as AOL Instant Messengers (there is more than 100% because users often use more than one client). Google Talk is a non-factor practically abandoned project, and Microsoft one-two punch could bury this market for good.
- Advertising revenue. Microsoft pulled in $1.5 billion from its online services division in 2007, most of it in ad dollars, losing $510 million. Yahoo made $7 billion in 2007, turned a profit of $700 million, on $6.088 billion in advertising revenue. It isn’t quite Google’s $16 billion, but Yahoo is a profitable online advertising company, and gives Microsoft a strong, larger base to grow from. It will take seven year for Yahoo to make enough revenue to cover the acquisition cost.
Is the price too high? Perhaps, given that the market thought Yahoo was only worth $25 billion, not $44 billion. However, the stock has shot up to $29.21 in pre-market trading, just shy of the acquisition price, which means investors are confident Microsoft will be able to do it. Microsoft has only $7 billion in cash on hand, which makes you wonder where it would get the money to buy Yahoo. Either they are hoping Yahoo takes stock, not cash, or Microsoft plans on offering more stock to pay for it.
However, last year Microsoft acquired $22 billion in investments and sold $26 billion in investments, so in theory the money does exist, or could be found relatively easily.
But is Yahoo worth the money? According to an off-the-cuff analysis by Valleywag last month, Yahoo’s investments around the world are worth more than the company! Besides getting Yahoo, and the ability to compete with Google, Microsoft would get one-third of Yahoo Japan, or about $9 billion, 10% of Alibaba, or $1.7 billion, 40% of Alibaba Group, or $8-16 billion, among many other investments. Microsoft could sell off many of these units and recoup possibly $20 billion of the acquisition cost within a year or two, making Yahoo a bargain.
In Microsoft’s letter to Yahoo’s board of directors, Steve Ballmer says that one year ago, Yahoo’s board rejected Microsoft’s offer to buy the company, saying Yahoo had much potential upside due to project Panama. Ballmer says:
A year has gone by, and the competitive situation has not improved.
Ballmer argues that scale is very important factor in the online economy, and there is only one competitor who is at scale right now. The argument is that Microsoft and Yahoo cannot compete if they are not also at scale. He also argues that there is one player in this market who is increasingly dominating the industry and consolidating its power through acquisitions, and Microsoft and Yahoo can together present a viable alternative.
If Microsoft sells off useless Yahoo components, combines Yahoo and Windows Live products, takes advantage of the dual-headed research and innovation capabilities of both companies, and better monetizes the existing Yahoo than Yahoo ever did, then this acquisition could be the market breaker it needs.
Follow continuing coverage of the acquisition on this page.