YAHOO (YHOO: 28.38, +9.20, +47.96%) shareholders are heaving huge sighs of relief right now. Microsoft's (MSFT: 30.45, -2.15, -6.59%) bear hug of a bid for the leading destination on the web looks like an offer it can't refuse. So much for Yahoo being a value trap.
As for Google (GOOG: 515.90, -48.40, -8.57%) investors, this is hardly what they wanted to hear. Not after last night, when the search giant missed Street estimates and showed that its awesome growth rate is slowing. Still, the proposed union between its two biggest rivals is a testament of sorts to Google's dominance in paid search as well as a threat to that state of affairs.
It's certainly more fun owning Yahoo today. And it'll sure be nice for shareholders to get some of their money back. But what an inglorious closing chapter this would be for a company that once held out so much promise. At $31 a share, Microsoft's $45 billion offer represents a whopping 62% premium to Yahoo's Thursday closing price. We don't mean to rain on Yahoo's parade, but the fact that $31 a share seems so nice shows just how messed up Yahoo had become.
The company's disappointing fourth-quarter earnings report and lousy guidance late Tuesday knocked the stock down to levels not seen since 2003. Microsoft's offer has the shares rallying, alright — to a level they held just three months ago. And even if you bought Yahoo a year ago, $31 is just your money back.
It's possible — but not probable — that another bidder will emerge. At least the market doesn't think so: Yahoo isn't trading above $31. And it's easy to see why. Microsoft has a market cap of more than a quarter of a trillion dollars and about $21 billion in cash and short-term investments. The sheer size of the offer will make it very challenging for Yahoo co-founder and chief executive Jerry Yang to stay out of Microsoft's clutches.
"I think Microsoft is the last company Jerry would want to sell to, but I don't think he's going to have a choice," says Darren Chervitz, director of research at the Jacob Internet Fund (JAMFX), which holds a stake in Yahoo.
The proposed deal is so big that any other suitor (except, ironically, Google) would almost certainly have to borrow money and offer more of its stock instead of cash. With credit markets tight and shareholders not enamored of dilution, where else can Jerry go? "I have a tough time seeing how management can do anything other than to get Microsoft to maybe raise its bid a little bit," Chervitz says.
Microsoft has courted Yahoo before, with good reason. With nearly 60% of the U.S. market share, Google has run away with the lucrative and fast growing search advertising market, and it's doing so at Yahoo's and Microsoft's expense. Those two command less than 20% and 10% of the market, respectively.
If a Microsoft-Yahoo combination manages to avoid the integration and execution pitfalls common to big mergers it could become a viable, perhaps formidable, competitor to Google, with the scale to be a clear No. 2 option for advertisers. But as for this changing the game for Google, I doubt that the three amigos of Mountain View are squirming in their massage chairs.
For one thing, as Citigroup analyst Mark Mahaney wrote Friday, the offer's valuation seems to support Google's current share price. I'd add that since Google is a faster growing, more nimble company than Microsoft or Yahoo, it probably deserves some sort of premium. And let's not forget how entrenched Google is as the search leader. Even if the deal gets done, it's not lights out for Google, Mahaney noted.
"We don't think a Microsoft/Yahoo! combination would change user behavior at all. And we could see a scenario by which Google would actually gain more market share due to industry uncertainty over the integration of the deal," Mahaney wrote. "...Our bias is that advertisers and search marketers would only shift their marketing spend if they believed the combination was generating a more effective advertising solution — which could take a very long time to prove."
If anything, the sight of its two chief rivals teaming up could justify Google's own considerable ambitions. For example, Microsoft objected to Google's proposed acquisition of DoubleClick, arguing that the marriage of that company's display ad business with Google's search ad dominance would be anticompetitive. The European Union has yet to approve the DoubleClick deal because of antitrust concerns. If Microsoft does indeed get Yahoo, it's hard to see how the EU could deny Google DoubleClick.
"In some ways Microsoft buying Yahoo should be somewhat irrelevant for Google," Chervitz says. "Part of me wants to say that Google is going to have a harder time gaining share, but they were going to have a harder time anyway. They're already at 60%. Google should probably be more concerned with companies coming out of nowhere, just like they did."
So whoo-hoo for Yahoo. Shareholders needed a Hail Mary and they caught it. As for Google investors, today's decline is painful. Hopes that lumbering Microsoft and plodding Yahoo will combine into a nimble competitor could weigh on the stock for some time. But Google's chances of getting DoubleClick are now much improved and its value proposition is unchallenged. MicroHoo isn't going to put Google out of business. So far, all the proposed deal has achieved is to make a good stock cheaper.
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