With Windows Vista continue to disappoint users and PC hardware designers continuing to produce ugly oversized desktops, Microsoft has apparently decided that Internet applications are the path to more revenue. It has offered $44 billion to Yahoo, which the Yahoo Board apparently rejected on Friday, despite the fact that the $31/share bid was higher than Yahoo has typically traded since mid-2006 (see http://finance.google.com/finance?q=YHOO and click on “1y” to get a chart).
The interesting question is why a company that claims to know how to program would pay anything for Yahoo, much less a P/E ratio of more than 60.
Google unseated Yahoo at a cost of about $20 million in financing, simply by being effective software developers and tasteful interface designers. We can infer from this offer that Microsoft expects its own programmers to be only 1/2000th as effective, dollar for dollar, as Google’s. In comparing Vista to XP and dividing by the amount of coding effort that went into Vista, it would be tough to argue with this conclusion.
[If I were a Yahoo shareholder, I would be looking at purchasing an old battleship right now, sailing it into San Francisco Bay, and lobbing some 16″ shells on the Board members’ houses in Atherton. The chance of a Yahoo shareholder ever getting more than $31/share, adjusted for inflation and risk, seems remote.]
[Additional thought… this could be a good new analogy question for the SATs… Microsoft is to Yahoo as Time Warner is to (correct answer) AOL. I recognize that it was AOL that purchased Time-Warner, but it was AOL that collapsed in value shortly afterwards, demonstrating that Internet giants can fall almost as fast as they rise…]
When they changed the SAT to a three-part, 2400 point version (adding a writing component in addition to math and English), they did away with the analogy portion, I believe. Sort of a shame, as analogies encourage outside-the-box thinking.
Beautiful analysis. The shareholders may indeed be angry, but I’m sure there are some Flickr and even Maps-via-OpenStreetMap users who’d be willing to take a few mortars for the board right now.
(Unfortunately, if Flickr does have only 1.5 million users, it’d cost them around $26K each to buy YHOO at current market capitalization. And with the board’s ultimatum, it goes up to nearly $36K apiece.)
Two things I that I think YHOO board members should be thinking:
(1) If DOJ and its EU equivalent do their jobs, there is no possible way a merger would be approved. This would be a costly distraction to their efforts to improve profit and stock price.
(2) Even if they do agree, if they don’t extract the maximum offer from MSFT, their shareholders may sue. News reports say that Microsoft may be willing to offer up to $35 per share, so in this respect the board members are merely doing what they are supposed to do.
Another thing: it will take years for Microsoft to digest Yahoo, what with converting their systems from various software to the Microsoft equivalents and the demoralization when most of the newly absorbed former Yahoo employees are let go within 18 months. If any of this purchase is in stock, it is in for a big fall. If I had stock in Microsoft, I’d be in Seattle, demanding Ballmer’s head.
I agree, Yahoo was crazy to pass that up. Folly offers like that don’t come along every day.
What I don’t understand is why Microsoft doesn’t just do what Yahoo and Google have been doing, which is acquiring promising start-ups -before- they cost billions. All of Yahoo’s innovative products like flickr are recent acquisitions that Microsoft could likely have outbidded them on for a few million. Buying Yahoo is just paying a middle-man a mark-up of a thousand fold.
If I had 44 billion to invest, I would just buy up any remotely promising startup. Even spent indiscriminately, 44B of those would almost certainly wind up having more value than Yahoo in the long run.
Another thing I don’t understand is why Microsoft doesn’t just reform the awful practices that led to Google and Yahoo getting all their online business in the first place. Hotmail used to be the standard online email, until they chased users away by deactivating accounts after 30 days and giving pitifully small amounts of storage. Yahoo solved both these problems, and promptly took all their email users.
Now they want to buy that customer base back for billions, rather than just making Hotmail an acceptable service? I suspect that if they had got Yahoo, they just would have ruined their own products with the same business practices.
“The interesting question is why a company that claims to know how to program would pay anything for Yahoo, much less a P/E ratio of more than 60.”
Surely Microsoft would have been buying Yahoo’s user base rather than Yahoo’s technology? Microsoft’s previous attempts at leveraging their desktop software to gain an internet audience created anti-trust problems, but purchasing customers through acquisitions avoids this (as it did with Hotmail).
The only rational conclusion I can see from this deal is to buy Google stock. BTW, AOL bought Time Warner, which is just as irrational today as it was then.
Even worse, Google are basically making their money from technology developed by Overture, owned by …
Microsoft is to Yahoo as IBM is to Lotus.
Hi!
Yours is one of the smarter objections to the deal I’ve seen. But even so I think it’s wrong. There’s a lot more to Yahoo than just search, or just search + email. What’s more, the surviving search traffic is probably driven in large part by the content businesses.
http://www.texttechnologies.com/2008/02/03/microsoft-yahoo-synergies/ outlines how complex the interaction between the two companies is. http://www.texttechnologies.com/2008/02/08/a-game-theorists-view-of-microsoftyahoo/ argues that the deal will actually happen.
CAM
David: Thanks for the analogy correction. I guess this proves that old guys shouldn’t take the SATs and that each generation has a higher IQ. I guess my main point is that the value in an Internet property is much less persistent than the value in a traditional company. General Motors took decades to decline; AOL managed to slide from being worth $100 billion or so into irrelevance within just a few years.
Alex: The terrible loss of value suffered by AOL and Time Warner showed that it was no longer enough to simply ‘buy a user base’. Around that time, a far too high value was placed on ‘bums on seats’. As another poster points out, Yahoo! mail made some serious inroads into Hotmail, and now those users are being bought back.
It seems obvious now, but the cost of changing loyalties is a lot different between switching between email providers, or going out and buying a new car of a different brand.
Also, Yahoo do have some great technology. The YUI library, and the great people who support it are a solid asset. However, Yahoo still need to develop some more products to match Google Docs. It would be great to see competition to Google in this area.
Phil mentioned two things google has going for it – good programs *and* tasteful interface. I think google’s interface is actually a *huge* factor in their favor. And while there’s some room for argument about whether microsoft has any good programmers, there’s one thing we can all agree on: they have absolutely no taste.
Not sure how acquiring yahoo is going to solve *that* problem. I think it’s bred so deeply into the corporate DNA that a cure is essentially impossible.
Expanding Thomas’ comment:
Following Yahoo!’s acquisition of Overture, the lawsuit was settled with Google agreeing to issue 2.7 million shares of common stock to Yahoo! in exchange for a perpetual license.
Will Microsoft become the proud owner of those 2.7 million shares?
Does Microsoft believe Google is currently infringing other Yahoo patents?
“Microsoft has shrunk by a Yahoo in the last eight days.” quoting Michael Arrington’s posting on
Microsoft’s $80 billion (and growing) Yahoo Headache.
Is there always a bigger fish or is it true that –
anyone can take anyone else out before you have time to blink. Its a dog eat dog world and targets can become predators.
Ray: Yahoo sold their GOOG stock extremely soon after GOOG’s IPO, see e.g. which shows them selling 2.3 million of their 2.7 million shares at $82.62 apiece (a typically inept [or, if you want, “typically unlucky”;-)] decision by Yahoo’s management: by selling their GOOG at such a fire-sale price, below even the IPO quotation, they got just $191 million, where they could have gotten $2 billions if they had been so incredibly smart as to sell the whole bunch at the historical top, and over $1.3 billion even at today’s less-exalted price for GOOG).
As for a patents-fight between the giants, it’s always a possibility, but hardly ever happens: every large firm has a large defensive portfolio of patents, threatening “mutually assured destruction” level retaliation should any firm actually making stuff ever try suing another (given the patent system’s fundamental brokenness, anything that’s actually MADE is sure to potentially violate dozens of patents anyway). Most patent lawsuits are brought by “patent vulture” firms that don’t actually MAKE anything (they just hold patents, and sue) and so don’t fear the obvious retaliatory measures.
No matter how good Yahoo’s technology is, MS will just discard it and use their own junk in its place. They replaced Hotmail’s FreeBSD system with Win2K, requiring twice as many servers to produce slower response and more downtime.
They’re going to do the same to Yahoo now. ReST, YUI, PHP, and FreeBSD will be discarded for SOAP, Silverlight, ASP.NET, and endless racks of Vista “Server”. It’s not possible for MS to allow non-MS technologies to survive in their corporate culture, because they fear contact with good systems will corrupt their drones.
I live and work in Seattle, and have had the misfortune of working with ex-MS employees many times before; they’re essentially lobotomized, useful only for the most trivial mechanical coding tasks, and are actively drawn to bad UI design, as if good design causes them physical pain. MS’s products really are the best they can do, and MS does a public service by locking up the worst programmers in the world.
On the bright side, Yahoo is an evil company that betrays its customers to the Red Chinese government to be imprisoned and tortured, so I feel no sympathy for them. They deserve what they’re going to get.
Yahoo!’s Board is not as stupid as you make them out to be. First, Yahoo knows that MS believes that Yahoo+MS together > Yahoo and MS separate. Second, no one should take the first price that is offered since there is no doubt that MS DID NOT offer the highest they were willing to pay. Yahoo most certainly HAS NOT mentioned the lowest they are willing to sell at. The 2 will meet at the bargaining table, and thrash out a price in between which will make both happy.
“while there’s some room for argument about whether microsoft has any good programmers, there’s one thing we can all agree on: they have absolutely no taste.”
I actually think that’s a misapprehension. Individually, many Microsoft developers have a well developed sense of taste, but Microsoft’s culture is such that design is moved late in the development process to designers who are non-core participants (disempowering both the developers AND the designers in this sense) and no argument with marketing against one more bullet-item for their checklist will ever be won on the basis of aesthetics.
So, Microsoft’s problem is that collectively it has no taste, even if many individuals within the organization do.
This of course mirrors many other pathologies that afflict Microsoft-the-organization, such as many unethical business practices despite most employees being extremely ethical, or pathological secrecy and doubletalk despite many employees being open and communicative. And so on.
A company that knows how to program and can pay for a P/E 60 outfit like Yahoo! is trying to buy time for something else. Search dollars alone aren’t it.
My guess is that something else is establishing pervasive .Net dependency outside the corporate LAN. .Net is Bill’s last hurrah, embrace-and-extend trifecta (and Yahsoft!, its Hail Mary pass): locked-in developers and server platforms, and web apps that ‘run best’ on Windows.
I wish people would stop quoting the PE as though it is the be all end all of valuing stocks. A significant amount of Yahoo’s stock price is made up of its minority stake in other companies. So in the P/E equation, the P includes those, but Yahoo doesn’t get to count the E from those companies. So just saying a 60x PE is a meaningless data point by itself. You really have to look at the complete picture.
Phil,
I agree with a lot of what you say but I would like to point out that the search market has changed over the years and the market’s perception of search has changed with it.
Sure Yahoo has screwed up but still, some of the blame has got to be on the shoulders of the financial types telling Yahoo how to run their business.
Here are my thoughts:
http://blog.tmcnet.com/blog/rich-tehrani/microsoft/microsoft-better-off-hiring-than-buying.html
“The chance of a Yahoo shareholder ever getting more than $31/share, adjusted for inflation and risk, seems remote.”
YHOO was above $31/share for a brief point in late October and that had nothing to do with the offer from Microsoft. Where is your evidence to back this statement up?
[I do own YHOO stock and I do think that if this offer never came through, YHOO would be able to get back up to $30 by itself.]
There does seem to be a reasonable chance of getting more money out of MS, so Yahoo’s board may well be right to try and get more by rejecting the offer at its current level. Its a question of weighing up the risk of MS walking away (I wonder if Steve Balmer is the sort of back down easily..), and the chance of making more money.
I do not think regulators will block the deal completely, but they might impose so many conditions that MS will not get what its wants and think better of it. If I were the regulator my response would be: you can have Yahoo’s search and advertising, Flickr and Delicious, but you have to sell off Mail, IM, Zimbra and any other Yahoo business that is in an area where MS is already strong.
Incidentally, it is common for European regulators to impose conditions like that. I would guess it occurs in the US as well.
Rob: Certainly one can check Google Finance (I used to use Yahoo Finance but have switched subconsciously in the last few months) and find that YHOO was $31 per share in October 2007 briefly, just as you said. Will it get there again? Maybe. But every month that goes by Google is consolidating its leadership over Yahoo and young companies are nibbling away at the corners. There has also been some bad mortgage-backed securities and recession news since October, if I’m not mistaken, dragging down all stocks. If the Fed cuts interest rates to 0.5% and we go on a big house-price and stock-price inflation spree again, I guess we could see a nominal price of $32/share, but adjusted for inflation I’m not sure it would be more than Microsoft’s offer.
Anyway, if Yahoo is worth $X right now as a standalone company, it is surely worth far less as part of Microsoft. Imagine the nightmare of integrating the companies, the technology, etc. There is no synergy that I can see. How does having the ability to patch Windows enable someone to build better Web apps? Microsoft’s big competitive advantage is that they control what goes into the overwhelmingly dominant desktop OS. I don’t see how that is an advantage for Web apps where users don’t want to run anything on the desktop except a standards-based browser.
Here’s a different answer for your SAT question: Microsoft is to Yahoo! as At Home is to Excite.
Flickr, Music, Finance, Go… I’m a shareholder and happy they didn’t sell. Microsoft won’t make anything of the company, and pockets and components within Yahoo! are finally waking up. Thoughts: here.
Bllaake: You may have a point there. Yahoo would give MS a large semi-captive audience to push Silverlight-based applications and content to. Combine this with the X-UA-Compatible crap they are pulling with IE8, and it might be a viable way of slowing or preventing the early-adopter trend of switching away from Windows from crossing the chasm to the mainstream.
At best though, this would be a delaying tactic borne of desperation.
Why do people talk about the AOL-Time Warner deal as if it were a failure? It was in fact a resounding success. Steve Case had a big stake in AOL, knew how hollow the company was and how unsustainable its market valuation was. He had to use that puffed-up stock to buy a company with substance before the inevitable crash.
He played Time Warner’s CEO Gerald Levin for a fool masterfully. If AOL had not done the deal, AOL shareholders would be much poorer. Of course, Time Warner shareholders were the losers in the deal, as they traded their valuable stock for worthless dot-commery. Once again, they were not the acquiring party, so it’s not their opinion of the deal that counts. The deal was a resounding success for AOL investors.
Foremost among TW shareholders was Ted Turner. He opposed the deal, but was powerless to stop it thanks to standard Corporate America malgovernance.
A simple point here really. It was easier to buy a user-base when the user had to drive to a different city to buy the same product, but now… new products are one click away. I like the Hotmail comparison, bang-on… Big G has been building lots of better and free products. So, even IF the system allows MS to buy Y! both brands will be left in the dust as Google goes further ahead. I think this is exactly why Google has been so quiet and neutral. Never go to war with yourself, which is exactly what the merger of MicroHoo will be.