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Yahoo stock falls as buyout talks end, but not as far as expected

Tuesday, May 6, 2008

SAN FRANCISCO -- Yahoo Inc.'s stock took a beating Monday after Microsoft Corp. withdrew its $47.5 billion takeover bid, but the punishment wasn't as severe as many analysts anticipated because investors suspect the rivals eventually will renew their mating dance.

Although Microsoft has publicly indicated it will focus on measures besides buying Yahoo in its bid to make its Internet division profitable, several analysts predicted the software maker will revive its bid in the summer or fall if Yahoo can't snap out of a two-year funk that exposed it to an unwanted takeover in the first place.

"Should the frustration of [Yahoo] shareholders come to a boil, we believe [Microsoft] could re-enter the picture, essentially playing the role of the white knight," analyst David Hilal of Friedman, Billings, Ramsey & Co. wrote in a Monday research note.

With similar opinions reverberating through the stock market, Yahoo shares shed $4.30, or 15 percent, to close Monday at $24.37. That wiped out nearly half the gain they made since Microsoft made its bid Jan. 31. The drop left the Sunnyvale-based company's market value about $12.5 billion below Microsoft's last offer.

"I was expecting to see a more extreme reaction," said Stanford Group analyst Clayton Moran. "Microsoft is trying to make it seem like it's not coming back [with another bid], but this somewhat muted reaction shows the market isn't buying it."

Meanwhile, Google Inc., whose lead in online search triggered Microsoft's bid, seems poised to benefit no matter how the talks go from here.

Microsoft ultimately offered $33 per share, only to be rebuffed over last weekend. Yahoo co-founders Jerry Yang and David Filo, who still own a combined 9.7 percent of the company's stock, flew to Seattle to demand $37 per share -- a price Yahoo's stock hasn't reached in more than two years.

The insistence on a higher price prompted Microsoft chief executive Steve Ballmer to yank his the offer off the table. Yahoo's stock price stood at $19.18 before Microsoft made its move.

Monday's backlash was enough to turn up the heat on Yang and the rest of the Yahoo board, which unanimously rebuffed Microsoft. The unrest could lead to a rebellion at Yahoo's still-unscheduled annual meeting, where shareholders could try to oust the board. Yahoo must hold the meeting by mid-July.

The blow to Yahoo's stock also was cushioned by expectations that the company will soon announce it's turning over some of its advertising space to Internet search leader Google Inc., whose technology yields higher profits from commercial links.

But many analysts think working with Google could be a mixed bag for Yahoo. While Google could boost Yahoo revenue by anywhere from $850 million to $1.6 billion annually, it might also hurt Yahoo by undercutting the appeal of its own ad platform.

An alliance between Google and Yahoo also would cause regulatory headaches because antitrust officials would to take a hard look at the partnership because the companies combined control more than 80 percent of the Internet's search advertising market.

While analysts debated how Yahoo and Microsoft should proceed, most agreed Google will benefit from the aborted takeover attempt.

Unnerved by the prospect of its two biggest rivals joining forces, Google reached out to Yahoo to help thwart Microsoft's bid.

Even if Google doesn't end up selling ads on Yahoo's heavily trafficked Web site, it has kept some of the Internet's biggest services out of Microsoft's clutches.

"We believe Google is a major winner given the failure of the Yahoo bid," Stifel Nicolaus analyst George Askew wrote in a Monday note. "Google is well positioned to continue to gain market share, benefit from any Yahoo (advertising) deal, and exploit any ongoing chaos at Yahoo and Microsoft."

Google shares gained $13.61, or 2.3 percent, to close at $594.90 Monday.

Time Warner Inc. also appears to be in a better negotiating position if it decides to sell its struggling AOL subsidiary, as many analysts anticipate.

Yahoo had been mulling a possible combination with AOL's online operations as a defensive measure against Microsoft. Now, Microsoft may make a run at AOL if it's interest in buying Yahoo is truly dead. And if Microsoft enters the picture, Google might offer to increase its 5 percent stake in AOL just to repel Microsoft.

A long list of Internet startups also could be in line for big windfalls if Microsoft and Yahoo step up their efforts to acquire more online weapons to challenge Google. And if Microsoft and Yahoo go shopping, Google has plenty of cash to get into bidding wars for potential takeover targets like Digg Inc., LinkedIn Corp. and Facebook Inc.

"Freed of one another, Yahoo and Microsoft are buyout prospectors: we would expect a rush-to-deal environment," BMO Capital Markets analyst Leland Westerfield.

Most analysts believe Microsoft has to make some kind of bold move after its online division lost $745 million through the first nine months of the company's fiscal year.

"Any notion of simply returning to the original, pre-Yahoo strategy is likely to be insufficiently defined and credible," Bernstein Research analyst Charles Di Bona wrote in a Monday note.

In a mild surprise, Microsoft shares fell 16 cents to $29.08 Monday. Most analysts thought the stock would climb because investors had driven down the shares during the last three months on worries that a Yahoo takeover would turn into an expensive mess.

Despite the drop in Yahoo's stock, Yang seemed thrilled to have maintained the independence that he and Filo started 14 years ago in a trailer while they were still graduate students at Stanford University.

"Has this experience changed us? Of course, it has," Yang wrote in a blog posting on Yahoo's Web site. "We've emerged a stronger, more focused company with an even greater sense of purpose."

If he wants to hold on to the CEO job he took on 11 months ago, Yang probably will have to show his turnaround strategy is compelling enough to propel Yahoo's stock beyond $33 per share within the next year.

Yang has promised a more sophisticated and far-flung ad network will accelerate Yahoo's net revenue growth by at least 25 percent in 2009 and 2010, up from the recent pace of 12 percent increase.

But Yang's credibility has been undermined by Yahoo's repeated forecasts of better times ahead while the company's profits steadily eroded during the past two years.

"We are not willing to give (Yahoo) the benefit of the doubt that they can make meaningful improvement over the next three years," UBS analysts Benjamin Schachter, Heather Bellini and Abhey Lamba wrote in a joint research note.

If Yahoo stumbles, that could entice Microsoft to return with another takeover bid that would be more difficult to turn down.

Venture capitalist Todd Dagres of Spark Capital likened this approach to that of a crocodile. "Rather than try to eat its prey while it's warm and tough, (Microsoft is) dragging it down to the bottom of the river, sticking it under a rock and eating it later when it's cold and soft," he said.


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