Yahoo Rejects Microsoft's Bid; Google's Ad Revenues Hiccup

Published: February 13, 2008

by Alex Woodie

Microsoft's quest to buy Yahoo entered a new phase this week when Yahoo's board of directors unanimously rejected Microsoft's $44.6 billion offer as "substantially undervaluing" the company. Nevertheless, Microsoft says it's determined to push forward to do the deal. Meanwhile, a new report shows Google lost market share in both online advertising and Internet searches late last year, potentially revealing a chink in the armor that Microsoft and Yahoo could exploit.

Microsoft first made merger overtures to Yahoo in late 2006, as the companies discussed their joint futures. The talks were done in private, and were only made public last week. Yahoo's management team rejected those early advances, saying they were better off going it alone against Google. They had plans, Yahoo's leadership said, that would boost its sagging revenue, and elevate its stock back to year 2000 levels.

When Yahoo disclosed its recent financial results recently, it became apparent that those plans, dubbed "Project Panama" by Yahoo, had not panned out. That's when Microsoft offered $31 per share, payable in cash and Microsoft stock, to buy out Yahoo shareholders and take over its search, advertising, and applications empire. The offer included an incredible 62 percent premium above the most recently closing price of Yahoo's stock, leading many analysts to predict that the offer would be too good for Yahoo to turn down. (Because the deal was half composed of Microsoft stock, it's now valued at about $41 billion as the result of a decline in Microsoft's stock price over the last two weeks.)

But, as it turns out, the offer wasn't too good to turn away. In an announcement Monday, Yahoo says its "board of directors has carefully reviewed Microsoft's unsolicited proposal with Yahoo's management team and financial and legal advisors, and has unanimously concluded that the proposal is not in the best interests of Yahoo and our stockholders."

Microsoft, in response to Yahoo's rejection letter, said it will continue attempts to get the deal done. "Based on conversations with stakeholders of both companies, we are confident that moving forward promptly to consummate a transaction is in the best interests of all parties," the company said in a statement.

The software behemoth raised the specter of the Yahoo deal turning hostile when it went on to state that it "reserves the right to pursue all necessary steps" to complete the deal with Yahoo shareholders.

There appears to be several potential outcomes at this point. Microsoft could up the ante and offer even more money to Yahoo until they reach an agreement. Yahoo's board reportedly would like the offer raised to $40 per share, which would make this a $52 billion deal for Microsoft.

Or, Microsoft could go hostile and attempt to buy a majority of Yahoo shares on the open market. If Microsoft does that, it could convince Yahoo's board to dust off the poison pill defense that would make the acquisition prohibitively expensive for Microsoft.

There's still a remote possibility that another media company, such as Time-Warner, Fox, or even a group of private equity investors, could play the role of "white knight" and rescue Yahoo from its unwelcome pursuer, or join the bidding war. Last but most unlikely, Yahoo's large institutional shareholders could petition the board to grab the $44.6 billion offer while it's still on the table.

Meanwhile, new data from IDC suggests that Google's stranglehold on the online advertising market loosened just a tad during the fourth quarter of 2007.

The industry analyst estimates that Google's share of the market for U.S. Internet advertising dropped half a percentage point to 23.7 percent from the third quarter to the fourth quarter of 2007. The company's year-over-year growth rate for the quarter was still 40 percent, but that was considerably less than the 50 percent growth rate Google had the previous year. The U.S. online ad industry as a whole grew 27 percent for the year, to $25.3 billion, IDC says.

So what does this mean? If Google's dominance of the market is starting to slip, does that help or hurt the chances of Microsoft completing its acquisition of Yahoo?

According to Karsten Weide, program director in IDC's media and entertainment services division, Google's slip is Microsoft-Yahoo's gain. "If a merger between Microsoft's new media business and Yahoo would come to pass, the combined entity would have a net U.S. advertising market share of about 17 percent, based on our 4Q07 data," Weide says in a statement. "It would not quite bring Microsoft-Yahoo to where Google is in online advertising in the U. S., but it would give them a much better fighting chance than if they went it alone."

While Google's growth in ad revenue is slowing, it's dominance of the Internet search market also diminished ever-so-slightly late last year, according to statistics published by Nielson/NetRatings.

Google was the engine behind 57.7 percent of all Internet searches in November, while Yahoo had 17.9 percent of the market and Microsoft 12 percent (or about 30 percent for Microsoft and Yahoo combined), according to Nielson/NetRatings (which will likely publish its January data next week). By December, Google's share had dropped to 56.3 percent, Yahoo's was essentially flat at 17.7 percent, and Microsoft's rose to 13.8 percent, giving Microsoft and Yahoo a combined 31.5 percent share of the market.

These numbers don't quite jibe with the numbers that Microsoft used two weeks ago to justify its acquisition of Yahoo. According to Microsoft, Google has more than 65 percent search query share in the U.S., and is even more dominant in Europe, with an 85 percent share. But no matter how you cut it, Google is the dominant player in online advertising and search, and Microsoft desperately wants a larger piece of the pie.

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