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Microsoft, Yahoo moving into endgame

As Microsoft campaigns to take over Yahoo, the Internet icon is strengthening its hand, and Microsoft may have no choice but to go hostile to win its prey.
/ Source: contributor

As Microsoft campaigns to take over Yahoo, the Internet icon is strengthening its hand. Yahoo has made a series of maneuvers in the past few weeks to shore up its stock price, and as a result the newest wrinkle in the ongoing takeover saga is that Microsoft may have no choice but to go hostile to win its prey.

Yahoo recently pursued two new Web initiatives — a deal to merge with AOL and a search outsourcing alliance with Google. These tactics help Yahoo make a case for a higher takeover price than the $31 per share that Microsoft originally proposed, say analysts, and they are ammunition that Yahoo can use to fight off Microsoft’s ultimatum — agree to be bought at our price or face a hostile offer at a lower price after an April 26 deadline.

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“The chances that Microsoft will go hostile are much higher now,” said Jeffrey Lindsay, an analyst at Sanford Bernstein. “Yahoo feels that it now has alternatives,” he said, adding that he believes Microsoft will even end up raising its bid for Yahoo to as much as $33 share.

But Yahoo still has one ace up its sleeve. Its quarterly earnings are due to be reported on Tuesday and analysts think they will be in line with Wall Street’s forecasts, despite a weakening economy.

"The difficulty is that Microsoft is running a hard bargain and will likely take Yahoo's positive results with a grain of salt," says Gene Munster, an analyst at Piper Jaffray.

Hostile takeovers in the Internet world are rare, though, and analysts think that if Microsoft does go hostile it will sweeten its bid before shareholders even get to vote on the offer.

The biggest reason is that Yahoo’s big institutional shareholders now want a higher share price from Microsoft, even though just a few weeks ago they favored being sold to Microsoft at the original $31 asking price rather than no takeover offer at all, insiders say.

This development makes Microsoft’s path more difficult. Yahoo’s recent test of Google ad technology points to the most promising share-boosting tactic, say analysts. Lindsay thinks that a Google deal, which currently is in a two-week trial phase, could boost Yahoo’s value substantially.

“Google is going to pull out the stops to work with Yahoo,” said Lindsay.

For its part, Microsoft is unlikely to back away. Microsoft has already hired the M&A firm Innisfree, which structures proxy battles. The software giant reportedly has lined up a proposed board it can nominate at Yahoo’s next annual shareholders meeting, if it does not accept its offer by the April 26 deadline. That board would replace Yahoo’s 10 directors if Microsoft is successful in a hostile bid.

Microsoft also reportedly has hired the Washington lobbying firm Brian Cave Strategies to help it get through any antitrust hurdles. “Microsoft is on a well-planned-out march,” says Munster. “It’s just executing on that plan.”

Although a hostile bid could create friction with Yahoo executives, it may end up to be the  cheaper route for Microsoft. A hostile takeover bid can cost tens of millions of dollars, but that compares to $1.4 billion for each dollar per share that Microsoft raises its bid.

There is a lot at stake for Microsoft in its battle with archrival Google, which owns 70 to 75 percent of the nation's profitable search ad market. Yahoo has about 15 percent of the market, according to IDC, while Microsoft ranks a distant third.

Though Yahoo may be damaged in the takeover battle, Microsoft doesn’t seem to care, according to Munster. Microsoft needs to boost its online business, said Munster, who also believes Microsoft will end up sweetening its bid.

“Yahoo is willing to do dramatic things to unlock [Yahoo’s] value,” said Munster. “And Yahoo has empowered stockholders” with this tactic.

Recently, Yahoo’s biggest shareholder Capital Research and Management doubled its stake in the company from 5.2 percent to 10.1 percent.

“Capital Research holds stock in both Microsoft and Yahoo,” explains Bernstein’s Lindsay. “Either way, it will be protected.”

However, Legg Mason’s portfolio manager Bill Miller told The Wall Street Journal that Microsoft’s current offer “is not something that I’m too excited about.” Legg Mason is Yahoo’s second largest shareholder, owning 7 percent of its shares as of Dec. 31.

Experts predict that the grind of a proxy fight will start soon. Most onlookers are still betting that Microsoft will play the winning hand. The only remaining question: At what price?