Microsoft puts Yahoo in play

The big news on Friday was Microsoft’s bear hug letter to Yahoo’s board. The news was announced before market open on Friday, and the >60% premium in Microsoft’s offer was quickly arbitraged away, leaving a much smaller spread (<10%) Wired today notes that the cultures might not be as far apart as everyone thinks. What will be key in this culture match, we predict, will be the drive to combat Google’s dominance in search advertising and related fields.

Perhaps Microsoft saw this article about the lopsided market valuation of Yahoo in relation to its various operating businesses and minority interests. This sort of arbitrage, calculating the break-up value of companies, doesn’t necessarily lead to the idea that a company will or should be broken up. For Yahoo, the key point might be that its minority interests are separate enough from the core business that they can be sold off for cash with little or no change to the value of the core. Similarly, looking at those minority interests and smaller segments is important for a strategic buyer such as Microsoft because that’s where opportunities for synergies come from. Sure, “reducing back office costs” is a common-enough source of cost savings, but companies with significant goals need to look for ways to improve the top line as well. In another context, we’ve told more than one small-business client: “you can’t cost-cut your way to growth.”

We will try to put together a post on the merger-arbitrage opportunity for Microsoft-Yahoo to further illustrate that aspect of the hedge fund business. The challenge for us will be to eliminate discussions of our proprietary modeling factors while still providing value for our readers. But we’ll try. Finally, the interesting way to analyze this deal will be the effect on Google. Clearly, Google is subject to surprisingly large swings in its price, 5 or 6% at a time. That is a huge volume of money given the market cap. If Microsoft and Yahoo sign a deal, what does that mean for Google? One could argue that Google is already competing against these two companies and so there is no real change; neither Microsoft nor Yahoo seems to have a viable strategy lacking only the resources to execute it; they are far, far behind in market share. What does a merger really open up in terms of competitive power? That is the $6,400,000,000 question (about 4% of Google’s market cap).

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