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Friday, February 01, 2008 2:57 PM


Microsoft Panics, Overpays For Yahoo


The tech news of the day is Microsoft offers $31-share, $44.6 billion, for Yahoo.

In a dramatic move that could significantly reshape the Internet industry, Microsoft Corp. on Friday offered to buy Yahoo Inc. for $44.6 billion in an effort to team up on online-advertising juggernaut Google Inc.

Microsoft (MSFT) said its "compelling" offer of $31 a share, in half cash and half stock, represents a 62% premium to Yahoo's (YHOO) closing price Thursday. Yahoo's market value has been pared recently by continued poor performance, stirring speculation that such an acquisition offer was imminent.

In a brief statement, Yahoo said it "will evaluate this proposal carefully and promptly in the context of Yahoo's strategic plans and pursue the best course of action."

The bid underlines the importance of the online advertising market to Microsoft, which company executives say could double to $80 billion within three years.
In addition to search advertising, a combined Microsoft and Yahoo would also present a stronger competitor to Google in market of advertising networks that extend beyond the companies' own Web sites.

Google on Thursday disclosed some recent difficulty in its network, saying that it has struggled to present advertisements on social networking sites such as partner MySpace.com that attract active user interest.

But earlier this week, Yahoo posted a sharp drop in fourth-quarter profit and said it would trim its workforce. The results dented Yahoo's stock, sending the shares to their lowest level since October 2003 and making the company more vulnerable to buyout offers.

Overall, Microsoft said its combination with Yahoo could generate annual savings of $1 billion, driven by research-and-development critical mass, operational efficiencies and increased value for advertisers.
Microsoft Panics

The offer is "compelling" alright, but only for Yahoo. Let's start with the idea that Microsoft might generate annual savings of $1 billion. It will take a long time at that rate to justify paying $44.6 billion in cash and shares.

Microsoft Balance Sheet


click on chart for sharper image

With a hat tip to Professor Jeffery, here is a table of Search Share Rankings from Nielsen.



click on chart for sharper image

Microsoft blew all of its cash on hand to pick up less than 18% of the search engine market. Microsoft and Yahoo combined only have a 31.5% share compared to Google's (GOOG) 56.3% share.

The Big Picture

Barry Ritholtz has many questions about Microsoft Takeover Bid for Yahoo!
Why is Ballmer & Co. paying such a big premium? Does this imply the entire Tech market is hugely undervalued -- or is Microsoft (MSFT) desperate to catch up with Google (GOOG)?
Answering his own questions, and which I am in agreement, Barry concludes:
Mister Softee's biggest cash cows -- Windows and Office -- look shakier than they ever have. There are real competitors for PCs (Apple, Linux) and lots of free or nearly free office software (Open Office, Google Apps). I assume Microsoft is projecting out current trends 5 and 10 years; they might truly believe that if they can't compete in the online search/advertising space, they are in trouble.

Here's the ironic part: The 2 most visible losers in the search area may be getting together -- and somehow, that's worth 150 point swing to the Dow futures.

I guess the negativity isn't quite as excessive as some people claim!
Reasons To Own Microsoft Shrink

One of the reasons to own Microsoft was that someday it would do something intelligent with its huge cash hoard. So far it has attempted to prop up its share price with huge special dividends, and now it is willing to part with every penny on its balance sheet to buy Yahoo!

With this offer, Microsoft has somehow decided this is the bottom for tech. I disagree. Furthermore, it is extremely unlikely that anyone else could possibly come up with $44 billion to buy Yahoo in this market climate. So what's the rush?

Heading into a consumer led recession was Yahoo!'s ad revenue going to significantly jump? No Chance! Even Google is struggling to grow.

Everyone, including Microsoft is underestimating how deep this recession is going to get and what that might do to earnings. Had Microsoft waited, it might have been able to get Yahoo! for 1/3 or even 1/4th the current offer.

Yahoo!Finance (the only thing I ever use Yahoo for), shows the P/E of Yahoo to be 55. That is hugely overpaying even in a good environment, and is preposterous heading into a recession that figures to be both long and nasty.

Microsoft panicked and it wasted its cash on hand in doing so. I see no other reasonable way of looking at it. This deal is not good news for Microsoft shareholders. Longer term, it's not good news for tech at all. When the real time comes to buy, companies like Microsoft will have already blown their cash.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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