Yahoo - Still Not Feeling MSFT, Now Talking To AOL

I read this morning that Yahoo & AOL are actually in talks about a possible partnership which (they hope) could help fend off Microsoft's friendly advances. This news comes on the heels of last week's discussion with News Corp.

Clearly, Yahoo is showing that it will consider any alternative to partnering with Microsoft. This is no longer about trying to drive the price up by $3 - $5 dollars. I can't see how a deal with AOL would be significantly more advantageous than one with News Corp. These guys are seriously looking for a "White Knight".

AOL has some similar products to Yahoo - and a merger would probably provide a whole new bunch of integration headaches which are sure to distract Yahoo's Mgt, at a time when they desperately need to provide stronger returns for Investors. According to the Silicon Valley Insider, If the companies combine, therefore, Time Warner could have about a 20% ownership in the New Yahoo. One hurdle to an AOL-Yahoo deal in the past, however, has reportedly been that Time Warner doesn't want Yahoo stock, which means that the deal would have to be done at least partially for cash. A private equity firm could provide some of that cash, but then the question would be: At what value will Yahoo issue the new stock--the post-Microsoft bid $29, or the pre-Microsoft bid $19?

Truth is, Yahoo is not going to find a Suitor better positioned to offer a strong incentive to it's shareholders, to sell out. It's also worth mentioning that -with Yahoo clearly struggling to build its Search Business, Google stands to gain even more in the short to mid-term and could lock up the Search Syndication / Distribution sector - for years to come.

Last week Friday (02/16), the World Street Journal reported that Alibaba, the Chinese Internet Company, part-owned by Yahoo Inc, has hired advisers to help negotiate for expanded management independence in the event of its U.S Partner, being acquired by MSFT.

Alibaba hasn't publicly commented on the Microsoft bid. On Friday, Jack Ma, told his employees that Alibaba management "will always maintain its independence and management control" over the company, regardless of who its shareholders are. Alibaba's reaction is not surprising, given the Chinese Governments involvement in Internet Companies.

I can't figure out why Yahoo is so dead set against this deal. It's doubtful that Microsoft will kill off any of Yahoo's priced assets, as this will certainly diminish the power of the Yahoo Brand, which is undoubtedly reflected in the $42B offer.

Yahoo's initial response indicated that "The board believes that Microsoft's proposal substantially undervalues Yahoo!, including our global brand, large worldwide audience, significant recent investments in advertising platforms and future growth prospects."

Fine, but it's safe to say that MSFT will probably come back with a higher bid - especially since $31/share bid has dropped. Both companies must know that by dragging this out, they risk losing talented Leaders & Mid-level Managers, in both Corporations. If Yahoo forces Microsoft's hand, and the Software giant decides to go hostile, that would be the worst possible scenario for Microsoft. Ultimately, Yahoo shareholders would prevail over Jerry Yang, he'll resign and a lot of his loyalists will follow suit. Many who are on the fence, will most certainly be poached by the likes of AOL, Google, IAC, eBay, Large Worldwide agencies and a host of start-ups

That would make the integration of Microsoft's OSG and Yahoo's Global Org, much more complicated and very expensive. What may have been a 1 year integration plan, could quickly become a 24 - 36 month affair. That would certainly have a significant impact in the $1B in gains and expected growth in Search Revenue & Query Share, which this partnership is expected to present.
For now, this saga makes for some very interesting commentary. However, I can only imagine how Yahoo employees are feeling right now.....

Microsoft -> Yahoo -> News Corp -> Microsoft ??

So, what's on Jerry's mind. First he get's a call from Steve - informing him of the Microsoft Bid. Then he get's a call from Eric - offering to help him out of the $44B bind. Not surprisingly Eric backs down in the face of the very obvious regulatory issues which would surely consume him and his Management Team. A relative calm ensues -which lasts all of a few minutes, before Rupert, steps up and professes his interest, again.

Jerry et al and Rupert have talked before but could never agree on the correct valuation for Myspace. Probably due to the fact that Social Networking Sites don't make a whole lot of money - relative to the sheer number of eyeballs they attract. Apparently, no one has figured out how to effectively monetize the Social Engagement piece -which faciliates user generated content and ultimately makes sites like Myspace and Facebook, so popular. The deal would allow Yahoo to remain independent while giving News Corp. substantial control over a huge array of Internet properties and advertising opportunities. Clearly a big win for News Corp - with very little upside for Yahoo! - so why go through with it?

The fact that this discussion is even taking place, gives an indication of the Yahoo founders feeling about selling out to Microsoft. Jerry wouldn't even consider this deal now, unless he was feeling the heat from shareholders -who have been pretty patient thus far. Let's face it - $44B is a lot of cash. So, ultimately, a sale to Microsoft still appears to the most likely scenario for Yahoo. And, apparently the MSFT Team knows it. There's no sign of anxiety in Redmond, even as Yahoo actively seeks alternatives. The company has said it is willing to "pursue all necessary steps" to consummate the deal, which could mean going directly to shareholders. Let's hope it doesn't come to that. A protracted battle, would be bad for morale at both Companies - and the only clear winner would be Google.......

MSFT Finally Get Some Street Cred

Microsoft delivered strong Q2 Revenue & Earnings. The Company announced record numbers for the Sept - Dec'07 period. Revenues were up 30% to $16.4 Billion. Operating Income was up 87% to $6.5 Billion & Earnings Per Share (EPS) were up 92% to $0.50 per share. It's worth noting that - even in this very volatile financial climate, Microsoft was able to generate strong results in all of it's key Business Units. Below is a breakdown - by division:

• Windows Client (Vista/XP): $4.3 Billion, up 68%
• MBD (Office/SharePoint): $4.8B, up 37%.
• Server & Tools (SQL Server/Visual Studio): $3.3 Billion, up 15%.
• Entertainment (Xbox & Zune): $3.1 Billion
• Online Services (MSN/Live): $863M, up 38%.

There appears to be little fear of a Recession hit in Redmond, as the Management Team offered strong guidance for Q3 which ends in March '08. Revenue is expected to be in the range of $14.3 billion to $14.6 billion. Diluted earnings per share are expected to be in the range of $0.43 to $0.45 and Operating income is expected to be in the range of $5.6 billion to $5.7 billion.

Full Fiscal Year guidance indicates that MSFT could hit the $60B mark in revenue - a figure normally reserved for Large Oil Conglomerates. Full year, operating income is expected to be in the range of $24.2 billion to $24.4 billion and diluted earnings per share are expected to be in the range of $1.85 to $1.88.

In the days ahead, I'll do a general comparison between Microsoft, Google and Yahoo. In particular, I'll hone in on the MSFT/Online Services Group - and provide my commentary how we stack up overall.....