Life After Microhoo

The Microhoo saga is dead. Long live Microhoo.

Microsoft's (Nasdaq: MSFT  ) gutsy move to walk away from Yahoo! (Nasdaq: YHOO  ) on Saturday doesn't have an air of permanence. If Yahoo!'s independence creates a downward spiral of falling share prices, booted executives, and shareholder revolts, there is little reason to think that an opportunistic Microsoft will scoff at the chance for bargain-priced redemption.

If it can snag the same Yahoo! (the one that it couldn't get at a sweetened $33 a share offer) practically handed to it by new management in the low $20s next year, you know that Steve "Buzzard" Ballmer is going to stay close, circling overhead to scout out the best moment for another dive down. 

Yahoo! shareholders are resentful. Microsoft investors are relieved. The rest of the market is shocked. Why did Microsoft bid against itself by presenting a higher offer? How could Yahoo! -- given the perfect opportunity to save face by arguing that it was able to squeeze more out of an already generous offer -- say no?

Plan B for Yahoo!
The market is bustling with activity as it dissects the news and ramifications, but it's hard to stomach this as the end. If you string along the logical chain of events, it seems that a lower Yahoo! share price will rile up the pitchforks and torches heading into this summer's annual shareholder meeting.

Investors will clamor for change, and likely get it. Yahoo! executives aren't doing much to help their cause.    

"Yahoo! is profitable, growing, and executing well on its strategic plan to capture the large opportunities in the relatively young online advertising market," Yahoo! Chairman Roy Bostock wrote over the weekend, defending his company's stance on refusing to budge after Microsoft sweetened its offer.

He's right about Yahoo! being profitable. The rest of his points are up for debate. Is Yahoo! growing? It certainly isn't growing on the bottom line.

EPS

2005

$0.58 adj.

2006

$0.52

2007

$0.47

2008

$0.47 est.

February's layoffs hint at a company that isn't growing in headcount. More heads are likely to roll if it hands over the monetization of its paid search business to Google (Nasdaq: GOOG  ) . Revenue has been inching higher, but a lot of that is coming from its recent buying spree. In short, this isn't the kind of financial performance that passes for growth in most camps.

Microsoft crashed Yahoo!'s party. If the unsolicited offer had never been made, Yahoo! investors would have been content with their shares meandering in the high teens, giving CEO Jerry Yang a few more quarters to see if improvements in display advertising -- coupled with the near-term financial windfall of outsourcing its search marketing business -- would pan out.

Yahoo!'s choices are limited, if only because the patience of its investors have been narrowed and the expectations widened. Companies such as News Corp. (NYSE: NWS  ) and Time Warner (NYSE: TWX  ) , which had been entertaining a combination of their online arms with Yahoo!, won't be wooed by the less buoyant share price and iffy leadership.

Yahoo!'s only hope is to hook up with Google on a paid search partnership, show explosive profitability in the first few quarters of the deal, and buy itself time to shore up enough non-Google revenue channels to spare management's hide.

Plan B for Microsoft
Microsoft has more options than Yahoo!. Ballmer comes out looking good after giving Yahoo! the opportunity to save face.  

None of this can disguise the fact that a once-proud Microsoft must be desperate if it was willing to sweeten a deal that was overpriced and dilutive to begin with. Investors saw it in last month's quarterly report, with flat revenue growth and a dip in profitability. Ballmer isn't on the hot seat over the stagnancy, but a few more quarters like that, and it won't be pretty.

Thankfully, Microsoft is blessed with an arsenal of cash. If it truly does not plan to revisit Microhoo, that money can be used to assemble the pieces to take on Google in cyberspace. There certainly is no shortage of attractively priced dot-com growth companies out there, companies that can be had for less and are growing more quickly than Yahoo!.

Microsoft reaching out to Yahoo! was an admission that it doesn't have what it takes to compete against Google organically. Now let's see it prove that by snapping up more than just aQuantive.

There's a brave new world out there, even for cowards who were ultimately too proud to get a deal done. 

Microsoft is anInside Value recommendation. Time Warner is aStock Advisor selection. You don't need to go on a treasure-hunting adventure to unearth any or all of the newsletter services. Sign up for a free 30-day trial subscription and find out which one fits you like a glove.

Longtime Fool contributor Rick Munarriz is a fan of Yahoo! and Microsoft, but not of bad weddings. He does not own shares in any stocks in this story. Rick is also part of theRule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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