Microsoft Plays Hard Ballmer

It's a lifeline. Or it's enough rope for Yahoo! (Nasdaq: YHOO  ) to hang itself if it's not careful.

Microsoft's (Nasdaq: MSFT  ) pointed missive over the weekend -- which puts Yahoo! on the clock to accept its buyout bid within three weeks -- is a flare that some in the media have mistaken for a warning shot.

Let's review the juicy nuggets in Saturday's stern note to Yahoo!'s board from Microsoft CEO Steve Ballmer.

The premium decision
The letter begins: "It has now been more than two months since we made our proposal to acquire Yahoo! at a 62% premium."

In reality, Microsoft's premium was greater than that. About $12 a share of Yahoo!'s share price at the time was represented by the company's Asian investments and cash, so the bid presented a premium that was closer to triple what the market thought the rest of Yahoo! was worth. I don't get why Microsoft doesn't make that point clear.

Beg, steal, or boardroom
"We've seen no indication that you have authorized Yahoo! management to negotiate with Microsoft."

This actually is a sign of good faith on Microsoft's part. It's almost inviting a counter-offer. I'm surprised to see the company use the word "negotiate" -- which invites haggling -- instead of "accept the deal" or other language that would imply that Microsoft started off with its ceiling price for Yahoo!

As my Web slowly weeps
"During these two months of inactivity, the Internet has continued to march on, while the public equity markets and overall economic conditions have weakened considerably, both in general and for other Internet-focused companies in particular. At the same time, public indicators suggest that Yahoo!'s search and page view shares have declined. Finally, you have adopted new plans at the company that have made any change of control more costly."

There is way too much truth in this paragraph to ignore. Since Microsoft's original offer, news has come out that the growth in paid clicks is weakening at Google (Nasdaq: GOOG  ) . In that time, Google and its ad-serving partners such as Time Warner's (NYSE: TWX  ) AOL and IAC's (Nasdaq: IACI  ) Ask.com have been growing market share at Yahoo!'s expense. If Google's stock has inched lower in the past two months, one can assume that Yahoo!'s stock would have fallen even harder if it wasn't for Microsoft's safety net.

The last point about "new plans" refers to the rollout of juicy severance packages to top executives in February, making an acquisition more expensive for Microsoft without Yahoo! shareholders benefiting in the money being funneled to Yahoo! execs. Why that last point didn't get the battering rams going is beyond me, too.

21 days to zero
"If we have not concluded an agreement within the next three weeks, we will be compelled to take our case directly to your shareholders, including the initiation of a proxy contest to elect an alternative slate of directors for the Yahoo! board. The substantial premium reflected in our initial proposal anticipated a friendly transaction with you. If we are forced to take an offer directly to your shareholders, that action will have an undesirable impact on the value of your company from our perspective which will be reflected in the terms of our proposal."

This is where suspense enters the chess game. Microsoft is giving Yahoo! three weeks to finalize a deal. The media is playing this out as a ticking clock -- with a direct threat of replacing its current bid with a lower bid in a proxy battle. 

But why three weeks?

Yahoo! reports earnings in two weeks, so Microsoft is giving Yahoo! the freedom to fail miserably in its first-quarter report -- something that may very well happen given the internal turmoil at Yahoo! and external relevance fade of Yahoo! -- and still accept the original buyout offer if it acts immediately after the report.

The myth of the Yahoo!'s independence
Despite the strong letter, Microsoft is going to great lengths to avoid ruffled feathers at Yahoo! It wants a peaceful resolution. It is still extending a hand down the flame-riddled fire escape, even as Yahoo! burns from the inside out.

No one knows what the Yahoo! boardroom is thinking. Yahoo! as we know it died in January. Yahoo! isn't on the clock now. That clock started ticking the moment Microsoft made its generous buyout offer.

If Yahoo! lets Microsoft get away, its stock reverts back to somewhere in the mid-teens. There is no other suitor. The companies that emerged as potential suitors, AOL and News Corp. (NYSE: NWS  ) , were looking to be bought out at Yahoo!'s market premium, more than the other way around.

Angry shareholders still around in three weeks will demand change. If Microsoft doesn't come through with a lower offer, they will demand a regime change. And they may get it. Yahoo! tried to pacify the Yahooligans by offering an upbeat outlook for 2009 and 2010, but no one trusts Yahoo!'s long-term vision.

This was the same Yahoo! that was optimistic about the Panama upgrade to its Yahoo! paid search product a year ago. That obviously didn't pan out. Unless Yahoo! is giggling inside, knowing that it will produce a quarterly report on April 22 that will blow pessimists to smithereens, that laughter is the only sound capable of drowning out the ticking time bomb set to go off on April 26.


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