Emerald Group Publishing Limited
Copyright © 2008, Emerald Group Publishing Limited
Microsoft Googles Yahoo!
Article Type: Rearview From: info, Volume 10, Issue 4
A regular column on the information industries
Google was the subject of a very recent Rearview (Curwen, 2008) and it is therefore something of a surprise that it should be featuring again so soon, even if this time it is playing a secondary role.
The primary players this time are Microsoft and Yahoo! On 1 February 2008, Microsoft launched an unsolicited takeover bid for Yahoo! worth $44.6 billion, offering to pay either entirely in cash or via a combination of cash and Microsoft shares. The bid priced each Yahoo! share at $31, a 62 percent premium to the price ruling the previous day. Microsoft justified the bid in terms of the need to take on a resurgent Google in the internet search market and claimed that it would lead to synergies worth $1 billion. According to Steve Balmer, the Microsoft CEO, the merged company would “deliver superior value to our respective shareholders and better choice and innovation to our customers and industry partners”.
Mr Balmer went on to point out that as part of previous correspondence between the protagonists, the chairman of Yahoo! had written to him in February 2007 claiming that it was inappropriate even to consider the possibility of a merger at that time because Yahoo! expected its reformulated strategy to deliver significant benefits to shareholders. However, these benefits had yet to appear and Wall St was becoming disillusioned, particularly in the face of Yahoo!’s forecast that its ebitda would drop by 6 percent as a percentage of revenue during 2008. But Microsoft was also becoming disillusioned because Yahoo! had agreed to co-operate with Microsoft in fighting back against Google’s dominance of the search market yet had not kept its side of the bargain. Furthermore, Yahoo!’s weakening financial position indicated that it would provide an increasingly less competitive counter-weight to Google as time went on. Given that MSN Search had only a 3 percent share of the market while Yahoo! had nearly 13 percent, any further decline on Yahoo’s part would effectively leave MSN as a permanent niche player in a market increasingly dominated by Google.
Although the $31 per share represented a substantial premium over the market price at the time, it is worth noting that the Yahoo! share price had previously slid by 45 percent from its 2007 high in October. Given Microsoft’s expectation in respect of potential cost savings, improved innovation and a sharpened responsiveness to opportunities in the video and mobile markets, it could be argued that Microsoft was paying over the odds. On the other hand, Yahoo! had stakes in Yahoo! Japan Corp. and Alibaba Group Holding Ltd. valued at more than $12 per Yahoo! share. However, primarily because of the stake in Yahoo! Japan which stood at only 33 percent (with Softbank holding a further 40 percent), Microsoft would need to pay out a further substantial sum - in excess of $20 billion - if it hoped to acquire full ownership over the pieces of Yahoo! that were the most successful.
The fact that the market price per Yahoo! share only rose to $28 after the offer was announced indicated clearly that Wall St did not expect a bidding war to break out if only because prospective white knights would fear taking on cash-rich Microsoft, but it was also acknowledged that regulators would not countenance a counter-bid by Google. However, the co-founders of Yahoo! - Jerry Yang and David Filo - held only 10 percent of the shares so whatever their personal antipathy to a Microsoft takeover of their company, the decision would ultimately be made by others.
Predictably, Jerry Yang, CEO of Yahoo!, did not even deign to reply to the offer. Google’s next move was to offer to help Yahoo! avoid the clutches of Microsoft although it remained unclear how it could do so, although it was suggested that it might help to finance a counter-bid by a third party. It was of interest that Yahoo! had recently been negotiating to outsource its internet search advertising in Europe to Google, reflecting the much superior advertising revenue that Google was generating per search. However, it was reluctant to have Google displace its name in the most prominent position on the web pages.
In essence, part of the difficulty lay in the fact that whereas the three companies had co-existed reasonably peacefully in the past, they were all now jockeying for status in the rapidly evolving world of mobile services. Google, for example, had unveiled plans to become a major player in the mobile operating system market with its Android initiative and had flagged its intention to bid for spectrum in the then ongoing 700 MHz auction in the USA, emphasising its intention to press for open access conditions. It had also provisionally acquired DoubleClick in December 2007 - confirmed in March 2008. By combining with Yahoo!, Microsoft clearly hoped to create an organisation with parallel skills.
Given the paucity of alternative options to the bid, the markets increasingly took the view that Microsoft would prevail and the Yahoo! share price rose into equality with Microsoft’s offer. However, since Microsoft’s own share price had declined somewhat, the total value of the offer had fallen to $41.5 billion, suggesting that Microsoft would have to make an improved offer if it wanted to prevail. Nevertheless, few doubted that it would prevail in the end, although they did have doubts about Microsoft’s ability to manage the integration of the companies - thoughts inevitably turned to the sorry tale of AOL and Time Warner.
It was argued that Microsoft had become vulnerable because of its reliance on the slow and expensive upgrade cycle to Windows and Office, and that these had led to regular and costly run-ins with regulators in the USA and Europe whenever Microsoft tried to fold new services into the package. The main threat to Microsoft’s reliance on desktop-embedded software accordingly lay in the possibility that more and more software could be delivered on demand from massive centralised servers or simply sent en masse by the likes of Google as a free service - but with advertising attached. By acquiring Yahoo! Microsoft would gain access to this service thereby giving prominence in advertising to its own software.
On 10 February, Yahoo! formally rejected the Microsoft offer. It was alleged that Yahoo! would only sell at $40 per share although the market price at the time was only $30 and few thought a realistic value to lie above $35. With a 9 percent stake, Yahoo!’s second-biggest shareholder (after Capital Research), Legg Mason effectively said that it would be agreeable to a deal at around that level. But Yahoo!’s board appeared to prefer a strategy of avoiding Microsoft’s clutches altogether, and to that end devised a plan whereby News Corporation would inject its online assets including social networking site MySpace pus some cash into Yahoo! in return for a stake of roughly 20 percent. This was held to be a potential coup for News Corp. but a poor deal for Yahoo! since it was hardly short of internet traffic whereas both parties were struggling to generate additional advertising dollars from Internet users. However, Rupert Murdoch was quick to point out that News Corp. was not going to get into a fight with Microsoft which had access to a lot more money than him.
Faced by these developments, Microsoft began to flag up the possibility of a hostile bid. This has rarely proved to be a successful strategy in “new economy” industries because they are heavily dependent on the talents of individual staff who can simply up and walk away. However, Microsoft appeared to take the view that it already had much of the necessary engineering know-how and that it would be able to get by even if some of Yahoo!’s engineers did decide to resign. In effect, what Microsoft was claiming was that the brand name, customer base and infrastructure - which would be comparatively unaffected by a takeover - were more valuable than individual employees.
Clearly, this sparring could not go on indefinitely, so by early March the battle lines began to be drawn up. On the one hand, some Yahoo! shareholders sued its board for rejecting the Microsoft offer. On the other, Microsoft prepared to nominate a slate of people to be nominated to sit on the Yahoo! board, thereby instigating a proxy vote fight at the forthcoming AGM. Clearly, the final outcome of this affair will be much delayed by regulatory wrangling, but it is indicative that the kinds of issues that underpinned alliances and M&A activity only a few years ago have been overtaken by a rapidly evolving pattern of use of the internet.
Peter CurwenVisiting Professor of Telecommunications in the Department of Management Science, Strathclyde University, Glasgow, UK. E-mail firstname.lastname@example.org
Curwen, P. (2008), “Should Google emulate Microsoft?”, info, Vol. 10 No. 2, pp. 96-8