Maybe They Didn't Dodge a Bullet

I'm about to blow your mind.

Remember when Microsoft (Nasdaq: MSFT  ) offered to buy Yahoo! (Nasdaq: YHOO  ) at $31 a pop last year? Maybe you recall when Electronic Arts (Nasdaq: ERTS  ) failed in its bid to snap up smaller video game publisher Take-Two Interactive (Nasdaq: TTWO  ) .

Microsoft and EA investors let out a collective sigh of relief when their deals fell apart like sponge cake inside a clenched fist. The market had initially pounded the prospective acquirers, fearing that they were overpaying for lesser companies.

Validation followed, as Wall Street hammered shares of Yahoo! and Take-Two after their headstrong ways finally scared away their incredulous suitors.

"See," Mr. Market said. "I told you they were no good for you!"

These facts seem so engrained in the memory of financial journalists that they have been relishing the retelling, in light of the search partnership Microsoft and Yahoo! announced last month.

  • "Others suggested that Microsoft had dodged a bullet by agreeing to a partnership as opposed to acquiring Yahoo outright in 2008." -- eWeek.com
  • "Meanwhile, having dodged a bullet, Microsoft used some of that unspent dough to perfect its new search engine, Bing." -- Forbes
  • "Microsoft knew it needed Yahoo! a year before it made its public offer in February of 2008, and while it may have actually dodged a bullet by not acquiring the whole company, Steve Ballmer and company have never relented on their quest to nail down a search deal with Yahoo!" -- LiveSide.net

Dodged a bullet, eh?

Now let me show you how to load a gun.

Trying sighs on for size
If you believe that Microsoft and EA skirted disaster, have I got a loaded table for you. Let's go over where each of the four stocks closed before the deals were announced. Then let's revisit where they are today. The acquirers have to be better off, right?

   

Then

Now

Loss

Yahoo!

Jan. 31, 2008

19.18

14.67

(24%)

Microsoft

Jan. 31, 2008

32.60

23.81

(27%)

Take-Two

Feb. 22, 2008

17.36

9.27

(47%)

EA

Feb. 22, 2008

49.74

20.40

(59%)

Source: Yahoo! Finance.

Didn't see that coming, did you? Drawing the starting line at the last trade before the world knew about the potential acquisitions, shareholders of the dismissed targets are holding up better than investors in the fed-up acquirers.

How can this be?

Well, maybe Microsoft and EA saw this coming all along. Their tenacious pursuit of Yahoo! and Take-Two through months of public scorn was the right thing to do. They knew that they didn't have enough going on internally, so they figured they could buy their way into growth.

I guess I didn't dodge a bullet, either
There's a flaw to my thesis. The starting lines ignore the buyout premiums. Microsoft wasn't going to pay $19.18 for Yahoo! It offered to cash out Yahoo! investors at $31 a stub. EA's final tender offer would have relieved Take-Two shareholders at $25.74 a share. If we go by those buyout prices, Yahoo! closed 53% lower yesterday. Take-Two investors would be down by a sharp 64% (though not too far from EA's 59% drop).

Hold back on the "a-ha moment," though. We can't ignore the cost savings and strategic strengths that would have been realized if the marriages had panned out. Yahoo! is looking for $500 million in incremental operating profits a year as a result of last week's search partnership. A physical combination would have been far more lucrative for the bottom line. If you think Bing's launch has been a hit, imagine if it had been the handiwork of a merged company with nearly a third of the search-engine market. Google (Nasdaq: GOOG  ) wouldn't be quivering in its boots, but its teeth probably would be chattering.

EA's deep bench and hefty coffers would have served Take-Two well, so that the publisher might have avoided its perpetual delays in shipping games. EA would have been able to bounce back quicker from the Spore hype letdown, and possibly milked Take-Two's Grand Theft Auto and BioShock franchises a little better. It would have given leader Activision Blizzard (Nasdaq: ATVI  ) something to worry about, and a legitimate battle for the industry's crown.

Every bridal bouquet has its thorns
In the end, there is a lot that we will never know. When Blockbuster (NYSE: BBI  ) threw up the notion of buying Circuit City -- 18 months ago -- it seemed like a ridiculous move. The video-rental chain dismissed the notion a few months later, and was ultimately vindicated as Circuit City liquidated its stores.

However, even then, Blockbuster may have missed out on a golden opportunity. What if beefing up its DVD stores with higher-end consumer electronics had propped up sales? What if two struggling leveraged companies could have stayed afloat longer?

As it stands, buying into Blockbuster has been no picnic. The stock was at $3.31 when the company announced its initial interest in Circuit City. It is trading 77% lower now.

The moral of the story is simple: You can't dodge a bullet, even at a shotgun wedding.

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Microsoft is a Motley Fool Inside Value recommendation. Google and Take-Two Interactive are Rule Breakers recommendations. Activision Blizzard and Electronic Arts are Stock Advisor picks. Try any of our Foolish newsletters today, free for 30 days.

Longtime Fool contributor Rick Munarriz isn't the type to rip up wedding invitations, even after the brides have been left at the altar. He does not own shares in any of the stocks in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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