MicroHoo Now All But Dead

Published: June 18, 2008

by Alex Woodie

Any potential deal between Microsoft and Yahoo now appears all but dead in the wake of terminated discussions between the two companies last week, and revelations of Microsoft's extremely low-ball offer for an alternative partnership deal. While Microsoft left the partnership door open just a hair, Yahoo slammed it shut in Microsoft's face and added insult to injury by finalizing an advertising outsourcing deal with Google.

The latest (and most likely the last) round of talks between Microsoft and Yahoo ended last week, and by all accounts, the talks did not go well. According to the Seattle Post-Intelligencer, which intercepted an e-mail sent to Microsoft employees by Platforms and Services Division president Kevin Johnson, discussions between the two companies centered on a Microsoft offer to buy Yahoo's search business for (drum roll please) the whopping sum of $1 billion.

That's right, one billion dollars. Even Dr. Evil would have realized that significantly underestimated the marketplace valuation of such a sought-after asset.

But wait, there's more! Along with the $1 billion to acquire Yahoo's crown jewels, Microsoft would make an $8 billion investment, at $35 per share. So, for a $9 billion investment, Yahoo would have given up its successful search business (which Yahoo wouldn't sell for $47 billion) and allow Microsoft to become a large stakeholder in the company.

That's less than half the amount people had speculated Microsoft would offer Yahoo for its search business when the companies started exploring alternative deals four weeks ago following Microsoft's withdrawal of its $31-per-share offer for the entire company.

According to Johnson, the new partnership "would have created a stronger competitor to Google, providing greater choice and innovation for advertisers, publishers, and consumers," he wrote in his e-mail. "This approach could have been implemented quickly and would have simplified the integration process for both parties. It would have also established the basis for a long-term Internet partnership between Yahoo and Microsoft."

Yahoo played along, and last Thursday announced that, "after careful evaluation," the board decided against sealing the deal. "[D]iscussions with Microsoft regarding a potential transaction--whether for an acquisition of all of Yahoo or a partial acquisition--have concluded," the company stated in an announcement.

Microsoft wasn't quite done yet, however, and issued a statement saying that, while Microsoft is no longer interested in buying all of Yahoo, "our alternative transaction remains available for discussion." The company apparently wants everybody know who walked away from the deal. It was Yahoo. But at $1 billion for Yahoo's search business (not the $20 billion originally envisioned, which also seemed low), it wasn't much of a deal.

With Micro-Hoo off the table, Yahoo took the opportunity to seal its pending deal with Google for paid search and advertising. The non-exclusive deal enables Yahoo to run ads supplied by Google alongside Yahoo's search results and on some of its Web properties in the United States and Canada, while running ads from other companies and its own "Panama" advertising engine.

The deal will bring in $800 million per year, and generate $250 million to $450 million in incremental operating cash flow during the first 12 months, according to Yahoo. It also puts 90 percent of the online advertising marketplace into the hands of Google, according Microsoft.

Things obviously didn't work out the way Microsoft had planned when it set out to buy Yahoo. The Web company has fought any potential deal tooth and nail, and perhaps harmed itself by turning down Microsoft's $47-per-share offer, as evidenced by Yahoo's collapsed share price and subsequent partnership with Google. But Microsoft is not without blame, and has given mixed signals about its intentions. But one thing is for certain: Microsoft didn't intend to chase Yahoo into the Google camp, which only strengthens its biggest competitor.

The last remaining wildcard in the deck is Carl Icahn, the billionaire activist investor who has been pushing Yahoo to make a deal with Microsoft. Icahn owns more than $9 billion worth of Yahoo, and is still vying to unseat Yahoo's board with directors of his own during Yahoo's upcoming shareholder meeting on August 1.

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