Will Microsoft make a new bid for Yahoo? It’s hard to tell. Certainly, not much has changed fundamentally on this deal.
We think that the compelling reasons for this merger are still valid and Microsoft is just playing hardball while watching Yahoo stumble. It may be well deserved. Jerry Yang has particularly poor negotiation skills (he is just too close to his creation), and Microsoft is probably tired of dealing with him. Carl Icahn did not help the situation. Carl’s sledgehammer diplomacy alienates this crowd, no matter how right he is.
Microsoft is now walking a tightrope as they let the catch squirm in the net. They may want to force Yang out and they may be trying to get Yahoo for a lower bid. The former is probable, but the latter is not. In the interim, there is an unprecedented brain drain going on at Yahoo, some is welcome, but not all. Microsoft and Steve Ballmer need to act expeditiously if they are to act at all.
Let’s look at some numbers.
Yahoo controls approximately 20% of the online advertising market which is slated to grow from $40 billion in 2007 to nearly $80 billion by 2010. Microsoft controls about 9% today.
This implies that if Internet marketshares remain relatively constant, Yahoo’s revenue will grow from ~$8B today to $16B within 3 years. More importantly, it implies that the cumulative gross profit for Yahoo will be somewhere just shy of $20B during the 3 year period from 2008-2010. A combination of Yahoo and Microsoft would reduce operating expenses by approximately $1B per year making the 3 year cumulative gross profit approximately $23B.
Running these same numbers for five years yields an even more interesting story. Yahoo revenue would rise from $8B to $22B, cumulative gross profit would be $40B and reduced operating expenses would total $5B for a cumulative 5 year gross profit of $45B, or $31.28 per Yahoo share. Just about the amount of Microsoft’s recent initial bid.
However, this is if the Microsoft-Yahoo combination did nothing more than maintain Yahoo’s market share. We think the new combination could easily take an additional 10% marketshare away from industry leader Google during this timeframe, adding an additional $20B of cumulative gross profit.
This provides a value to this deal with a five year ROI at $45-$65B, or $31.28-$45.14 per Yahoo share. A midpoint would be at $38.21 per share, or $55B. Jerry Yang’s $37 per share, or $35 per share are reasonable, but we think $34.75 is the number. $34.75 is $50B. Good premium, fast payback, round number.
Simply stated, this acquisition pays for itself in less than 4 years.
If Microsoft offers and acquires Yahoo for $50B (roughly $34.75), they are getting a good discount for their risk while providing the Yahoo board (and Jerry Yang) a real face saving opportunity. Quick action is needed to close a deal like this and it should be agreed to well in advance of the shareholder’s meeting on August 1st. This deal should close before the 4th of July holiday.
- This is still a good deal for Microsoft and it’s shareholders
- It provides Microsoft with an instantaneous gain in internet advertising marketshare and synergy
- Yahoo would be wise to accept the offer immediately
- Jerry Yang needs another assignment as part of the deal
- An agreement prior to the 4th of July is good for employee retention and has a touch of patriotism
- Microsoft, Yahoo, key shareholders, and Icahn need to discuss, agree, and make it friendly
- $34.75 is not too much for Microsoft and is a reasonable value for Yahoo and it’s shareholders
- Shareholders on both sides will like it, the industry and the media can move on
- $50B is a nice round number
