Friday, February 01, 2008

Deal of the Decade

Investors arose to the refreshing news of a buyout proposal from cash-rich Microsoft (MSFT: Nasdaq) for undervalued Yahoo!, Inc. (YHOO: Nasdaq). Finally, there is financing news of sufficient substance to elbow recession talk out of the way.

Microsoft is trying to remake itself, which is not easy to do for a company with $58 in sales and a market value over $280 billion. If Yahoo is receptive to a take over, it will be easy for Microsoft to pay the premium price it offered - $44.6 billion or a premium of 62% over the YHOO market value before the announcement. Microsoft has over $20 billion in cash and its stock has an acceptable value of 18.5 times trailing earnings.

Alas, I am on the wrong side of the deal - long MSFT (down $2.15 or 6.6%) and no position in YHOO (up $9.20 or 48%) on the news. At least for now, as this is the way the stock prices have shaped up in the first day of trading. How investors view the deal after deeper thought is another matter.

The question is - what difference would the transaction really make at Microsoft or Yahoo? Yahoo generates just over $7.0 billion in sales in 2007, just 12% of Microsoft’s sales level. The corporate cultures could not be more dissimilar. Will they need interpreters during the integration period? Perhaps Microsoft would just leave Yahoo! to fend for itself. I doubt the latter would be the case, since Microsoft is really looking to Yahoo’s Internet presence as a means to compete with Google.

A very pesky competitor, Google has chipped away at Microsoft’s Internet presence. Yahoo! could give Microsoft an expanded presence in online media and advertising. This could be a big plus for Microsoft, for example, in furthering its health care platform, HealthVault.

No doubt the columnists and pundits will be analyzing the proposal from all angles, all the while speculating on Yahoo’s response. Small-cap investors may think the deal is of no import to the sector. On the contrary, investors should take note of the deal if they have positions in smaller companies that have been counting on relationships with Microsoft or Yahoo! or Google.

We would expect a possible slowdown in negotiations of all kinds at Yahoo! while they formulate a response for Microsoft. If there is a counter proposal or prolonged negotiations, delays of one kind or another could ensue. On the other hand, Google principals could decide to accelerate some activities in anticipation of beating a newly fortified Microsoft-Yahoo! combination to the market with one application or another.

It is indeed deal of the decade with ramifications for more than just Yahoo! and its shareholders.

The author of the
Small Cap Copy web log has a long position in MSFT.

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