We now think it's more likely than not that Microsoft (MSFT) will withdraw its offer for Yahoo (YHOO) next week. This will likely send Yahoo's stock into the low $20s and Microsoft's up.
Here's why:
Microsoft's squishy quarter makes it less likely that Microsoft's rising stock will raise the value of Microsoft's bid on its own. (Ironically, of course, as the deal becomes less likely, Microsoft's stock will rise because of that--but we assume Yahoo is smart enough to know what would happen if it suddenly agreed to a deal.)
Yahoo has dug itself in deep enough that we don't see the company caving and agreeing to sell at this price--especially in the next two days. Jerry has demonstrated that he's not easily spooked, and he has to have been prepared for the possibility that Microsoft would walk. In fact, we think Jerry would see this as a victory (which it would be) even if many Yahoo shareholders do not.
We think lots of Microsoft shareholders and Microsoft employees hate this deal--as well they should, because it would be a disaster. We think the complaints and concerns about the deal expressed to Steve Ballmer over the past two months have probably made him think twice about the wisdom of fighting to the death for Yahoo, even if he'll never admit that. At the very least, they'll make it easier to walk way.
We think it will actually be harder for Microsoft to win a proxy fight at the current price that is commonly thought: At least 35% of Yahoo's stock is in the hands of folks who appear unwilling to sell without a price increase (Capital Group, Legg Mason, Jerry, David, and other insiders). If Microsoft is actually willing to raise its price, it should do so now--before launching a Pyrrhic battle that will last, at a minimum, 3-4 months, will distract and hurt both companies, and might fail.
Microsoft's public statements have now gone beyond threats to what appears to us to be acceptance and resignation. Maybe we're just falling for a negotiating tactic, but we don't think so. If Microsoft is going to seriously consider raising its bid next week--which, based on Yahoo's behavior, we think is now the only way to get this deal done quickly--it sure isn't acting like it. Cutting the price, meanwhile, would make it even harder for Microsoft to win a proxy battle.
Eight weeks ago, we thought this was pretty much a done deal. We thought the companies would find common ground around $35 and that an agreement would be reached relatively rapidly at that price, once Yahoo exhausted all its options. Now, based on the positions taken by both companies and the first quarter results, we think there's less than a 50% chance the deal will get done. At least in this go-round.
In the end, we did not like the location or ambiance of Yuki's Palette. But the food is the attraction at this restaurant and o this front, the restaurant delivers.
I think that most likely scenario is Microsoft will first raise its offer but stoke Yahoo's fears with the threat of a tender offer. I think that Yahoo's shareholders are very receptive to selling to Microsoft. While Jerry Yang was right about Yahoo being worth a lot of money, the shareholders may not want to bet their investment on whether his strategy and execution will work.
The best outcome for shareholders would be that Yahoo! re-positions itself and starts the growth engine that it once was. If they succeed in that, Yahoo's share price will end up being higher than the Microsoft offering price. One of the key questions is how long for it to reach that level.
Next best outcome is take Microsoft's offer with its guaranteed price.
The worse outcome occurs if Yahoo does not consummate this deal and Jerry and his management team are unable to follow through on their visions. Yahoo! will continue to lose value. This outcome is a disaster for shareholders.
In evaluating what is the best to do, we are faced with imperfect information similar to the old Prisoner's Dilemma. In that economic scenario, prisoners are forced to make a choice absent perfect information. They do make a choice that they feel is their best alternative but it turns out that they choose a less than optimal outcome as a result of their lack of knowledge. For Yahoo shareholders, they do not know how the Yahoo management team will perform (both on the strategy and execution side), so they should logically agree to the hostile offering (based upon the risk of management's failure). This way, they will receive a good return will an extremely low risk of loss.
There have been a few acquisitions in the internet space that have worked like Yahoo! acquisition of Overture, eBay's acquisition of PayPal and News Corp's acquisition of MySpace.
That being said, if Microsoft does acquire Yahoo!, the merger of the two cultures will be a monumental task that will sap vital business focus during a time when Google will be continually improving its own products and services. After two years of integration, Microsoft will finally be in the position to go after Google but by then Google will then own 90% of the market. Too little too late.
As a result, Microsoft is in effect buying an asset that will be depreciating in its hands so regardless of whether the price is too high now, they will be overpaying since its value will continue to decline.