Pull up a chair, this fight is a good one--if anything a high stakes merger provides a distraction from the gloomy housing mess and Bernanke's attempts to apply the paddles to revive the Goldilocks economy.
Google is offering to help Yahoo! fend off Microsoft's hostile $44.6bn bid for the Internet bellwether, and Google's top lawyer shot a torpedo right at Microsoft's weakest spot, antitrust issues, in a letter on Google's website. And now Microsoft apparently is threatening a boardroom coup at Yahoo! if it doesn't accept its mega-offer or sit down for talks.
But the battle royale obscures a more important question: Is Microsoft overpaying in its $44.6bn bid for Yahoo!, and what's really at stake?
Neil Cavuto and the gang here at Fox Business have been spit-balling this one, with Neil pointing out that Microsoft CEO Steve Ballmer is likely pulling out the stops with a big whopping bid to put a fence around the coveted Yahoo!, to shoo away other bidders. Already, AT&T, Comcast and News Corp. reportedly have no interest in buying. Neil notes that the all-chips-on-the-table approach appears to have worked in News Corp.'s successful $5bn bid for The Wall Street Journal.
Microsoft's offer is the biggest unsolicited bid in the U.S. since Comcast's unsuccessful $55bn offer for Walt Disney. Only two unsolicited deals of greater size have succeeded in the past decade--Pfizer's $110bn takeover of Warner Lambert, and Vodafone Group's purchase of Airtouch Communications, both in 1999, according to data from Dealogic.
So, let's break down the numbers—use this as a cheat sheet as the fight unfolds:
MICROSOFT HAS A HISTORY OF PANICKY OVERPAYING: Microsoft lately has been criticized by analysts for panicky overpaying in its $6bn purchase of aQuantitative, an online ad services company with ho-hum earnings (a deal price that came to a whopping 30 times aQuant's cash flow), as well as its $240mn purchase of a tiny 1.6% stake in Facebook, the online social networking site that has a microscopic $30mn in annual profits on an estimated $140 million in sales. That $240mn gives Facebook an implied $15bn valuation. Can Microsoft increase sales off of these assets, what's called 'monetizing' these operations? Remains to be seen.
A MINI-TECH BUBBLE = BIG WRITEDOWNS?Such overpayments create an exceedingly nasty bookkeeping item if and when these deals flop that can severely bite companies and investors later on. It arises when companies overpay for acquisitions, which ends up in an irksome line item on the financials called goodwill, loosely defined as the amount an acquiring company pays above and beyond a target companies' hard assets, the amount chucked at a company to seal the deal or to pay for things like the ephemeral brainstorms in a target's R&D operation.
Yes I am a geek, this is geeky stuff, but bear with me it's seriously important. If the company that's bought falls down and doesn't deliver, the acquiring company has to write off the amount paid. That can sting investors badly.
You've got to wonder if we're in some kind of mini-echo bubble lately. Just look at ebay, the internet flea market, which recently booked a whopping $1.39bn charge in the third quarter to erase its overpayment, largely goodwill, for the Internet phone company Skype (which booked a teeny $98mn in the quarter whoopee).
And watch out:Sprint Nextel warned it may soon wipe out nearly 90% of the entire $36bn cost of Sprint's disastrous 2005 acquisition of Nextel with a $31bn charge (and as our news director Ray Hennessey points out, the merged company's $29.7bn market cap is drastically less than Sprint's own $36bn market cap and Nextel's $33bn market cap at the time of the deal. Ouch).
We've seen this before: JDS Uniphase, a maker of optical communications, famously wrote down $44.8 billion in goodwill -- which was created when it acquired SDL, E-Tek Dynamics and other companies for more than their net assets. Time Warner's calamitous merger with AOL eventually led to a total of $95.5bn in writedowns in 2002.
Check this out:Google itself faces a potential big writedown for its whopping $1.65bn purchase of YouTube, a nosebleed premium to YouTube's hard assets or what are called tangible assets (in fact, Google's goodwill rose to $2.3bn from just $195mn in 2005 yikes watch out!) YouTube reportedly didn't see a penny in revenue until March 2006, when it began selling ads. Meanwhile it takes a lot of costly servers and data centers to manage YouTube's videos, 90% of which no one is interested in. Bandwidth costs alone also increase every time a visitor clicks on a YouTube video, and by some estimates had been approaching $1mn a month--much of which goes to provider Limelight Networks.
And don't forget, Yahoo! itself has been on a mini-acquisition spree, which has tossed off a big $3.5bn in goodwill, up from $2.9bn in January 2007.
IS YAHOO! REALLY CHEAP NOW?Yes, Yahoo!'s stock price is at a four-year low. Microsoft's offer was a huge 62% above Yahoo's market value and about four times Yahoo!'s book value. But Microsoft is plowing in at a time when a slowing online ad market has both Google and Yahoo hurting. Microsoft is trying to plug the one hole that's spilling red ink in all of its businesses, its online services division, which bled $510mn in losses the second half of 2007, more than twice the $232mn in losses for the same period a year earlier.
Yahoo! has already said it faces headwinds this year, as does everyone, and profits have been weak lately, falling 23% to $205.7mn last quarter vs $268mn in the year-ago period. In contrast, Google reported a 17% jump in earnings to $1.21bn vs the same period a year-ago.
Being an accounting geek there are a few line items in Yahoo!'s filings I don't like, with some positives:
Yahoo!'s expenses, costs for things like its overhead, product development, sales and marketing, all have been steadily rising. However its all important free cash flow—the free cash from its operations that help it expand, buy more engineers, pay down debt, do stock buybacks, create new services—has improved to $887mn in its last nine months, up from $649mn for the same period a year ago. It also has $2.4bn in cash on the balance sheet and between $5 and $10 a share in assets including investments in Yahoo! Japan and Alibaba Group, an Internet company in China.
Can Mr. Softie 'monetize' Yahoo!'s assets to justify the rich $44.6bn price? That really remains to be seen.
GOOGLE REMAINS THE MONSTER IN SEARCH:A Microhoo would have less than half the market share in search versus Google, 31.75% combined versus Google's mammoth 66%, according to Web measurement firm Hitwise. And critics say both Yahoo! and Microsoft have been behind the eight ball when it comes to creating services that would add to search, such as social-networking sites, online video, mobile advertising and games, with much of its sales coming instead from things like display ads on the Web pages within those portals.
Contrast that with Google's masterful search sales, including its land grab, where it earns more than a third of its sales captured from ads placed on other sites. Google also gets plenty of sales from ad clicks based on keyword-based advertising on things ranging from blogs to newspaper sites. With its search advertising overhaul falling apart, Yang was said last year to have considered outsourcing Yahoo!'s search advertising to Google, an offer Google apparently has since revisited to tempt it away from Microsoft.
ARE TWO SEARCH ENGINES BETTER THAN ONE?Not so fast. Search industry analyst and blogger Danny Sullivan points out that marrying two search engines has never created much more than a simple sum of market share, a boost that doesn't usually last. As evidence, Sullivan notes that the combined search audiences created by Excite's purchase of Webcrawler in 1997, and Yahoo!'s acquisition of AlltheWeb and Alta Vista in 2003, only eroded as Google grew.
ANTITRUST COPS ON THE PROWL:Microsoft has had historic knockdown fights with US and European Union antitrust busters. The company is now in round 2 of a nine-year battle it thought it closed with the European Union last September, where it paid record fines of $600 million to settle claims that it had iced out competitors by tying a range of software, including the browser Internet Explorer, to its dominant Windows operating system and by refusing to make its products interoperable with those developed by competitors. The EU recently went after Microsoft yet again, this time saying Microsoft is suspected of acting in an anti-competitive manner by retaining secret information about its most frequently used software, such as Word, Excel, Power Point and Access, which makes them incompatible with other products developed by competitors.
GOOGLE DOESN'T FORGET: Microsoft complained mightily to US antitrust regulators about Google $3.1 billion purchase of the online advertising outfit DoubleClick, filing briefs against the deal in the US and overseas, and also providing testimony to Congress on why regulators should block this deal. Don't think for a second that Google won't raise hell over Microsoft's bid. Already Google's lawyer is saying as much, with a letter on Google's website that suggests Microsoft will snuff out competition by leveraging its dominating Windows operating system. Microsoft could be accused of wanting to do things such as setting up personal computers so consumers are automatically steered to a Microhoo's online services, such as e-mail and instant messaging.
THIS FIGHT WILL GET UGLY: Steve Ballmer, Microsoft's CEO, came out swinging just this past Monday about the idea of a Yahoo-Google pairing, claiming that only a merger with Microsoft would create true competition. “Any alternative scenario actually doesn't seem to enhance competition and, certainly, that would be the message we will communicate to regulators,” Ballmer said in a conference call with financial analysts. “Google's clearly got a dominant position – they have about 75 per cent of paid search worldwide.”
CHINA NOT A PANACEA:Yahoo!'s stake in China's Alibaba Group and its Yahoo! Japan has given it one of the strongest positions in those two countries, as users pile onto the Internet there daily. China's internet users now number 210mn, up by more than 50% since 2006 and triple the number for India. China is now on track to have more internet users than America, Morgan Stanley says. And that 210 million is just 16% of China's total population, whereas stateside Internet penetration is about 80%. But again, not so fast.
The Chinese government has shut down its Internet to outsiders, and it censors all content, including video. China also shuts down domestic access to many foreign websites. The government also tightly controls online commerce, so e-tailing is virtually non-existent (eBay, the world's leading online flea market, bombed in its attempt to enter the Chinese market). Yes, Yahoo! owns a big stake in the Alibaba Group, but this company has rightfully been called more an electronic yellow pages, helping buyers find sellers, than an online auction house.