MicroHoo!: The Attempted Takeover of Yahoo!

By Microsoft

Case Overview

In February 2008, Microsoft launched an unsolicited bid for Yahoo at US$31 per
share. With Yahoo’s share price closing at US$19.18 the previous day, this
represented a 62 per cent premium and seemed like a deal not to be missed. However,
Yahoo’s management resisted all of Microsoft’s efforts to take over the company,
resulting in Microsoft withdrawing its offer in May 2008. The objective of this case is
to allow a discussion of issues such as the role of the board and management in a
takeover situation in the US and compare it with the situation in Singapore, the use of
anti-takeover defences, and whether the takeover benefits shareholders of the
acquiring and/or target company.

The Drama Unfolds: Sequence of Events

On 1 February 2008, Microsoft launched an unsolicited takeover bid for Yahoo,

hoping to tap on Yahoo’s search engine and online advertising resources which would
allow it to compete more effectively with Google. Microsoft offered to pay US$44.6
billion, effectively setting the bid price at US$31 per share. This represented a 62 per
cent premium over Yahoo’s closing price the previous day. Yahoo’s share price
immediately skyrocketed.

In mid-February 2008, Yahoo formally rejected Microsoft’s offer, claiming that

Microsoft had substantially undervalued Yahoo’s shares. Reports had indicated that
Yahoo’s minimum asking price was US$40 a share . Yahoo co-founder and CEO
Jerry Yang was seen by many as the main obstacle to the merger. Under Yang’s
leadership, Yahoo had enacted a controversial “poison pill” severance plan and it
commenced a search for a white knight investor.

With the fall in Microsoft’s own share price as well as to induce Yahoo shareholders
to pressure the board to sell , Microsoft raised its offer to US$33 per share. However,
Yahoo’s board rejected the offer, insisting on no less than US$37 a share.

On 3 May 2008, Microsoft said it was withdrawing its bid. On the same day, Yahoo’s
share price fell to US$23 and its share price dropped further to below US$20 in the
following few months. A number of shareholder lawsuits against Yahoo’s board
followed.

On 3 June 2008, shareholder activist Carl Icahn joined the fray. Icahn echoed the
charges in several lawsuits’ that “Yang’s deep hostility toward Microsoft” and his
“defensive and self-interested conduct” had scuttled the deal. Icahn also told The Wall
Street Journal that should his proxy campaign prove successful, he would try to oust
Yang, under whom Yahoo’s stock had plummeted from US$33.63 a share in October
2007 to US$26.15 a share, representing a drop of over 22 percent.

Microsoft’s Interest in Yahoo

Microsoft CEO Steve Ballmer viewed the merger between Microsoft and Yahoo as an
opportunity to strengthen Microsoft’s market position in the burgeoning online
advertising market, which was at that time dominated by Google.

A merger of the two companies would raise the combined entity’s advertising
revenues to US$4.74 billion. Although this still trailed Google’s US$6.12 billion , it
would serve as a more solid foothold for Microsoft in the lucrative US$40 billion
online advertising market over which Google MicroHoo!: The Attempted Takeover of
Yahoo! By Microsoft 186 currently holds sway. As allies, “Microhoo!” would reach
86 per cent of US Internet users and control 59 per cent of the online display
advertisement market.

Although Microsoft seemed to be offering what looked like an exorbitant premium,

especially considering Yahoo’s performance over the years, Microsoft expected to
realise synergies that would more than make up for it.

A letter from Microsoft’s Ballmer to Yahoo’s board of directors highlighted the

benefits that were expected from the merger, including: (1) scale economics, (2)
expanded R&D capacity, (3) operational efficiencies and (4) emerging user
experiences.
The merger was also purported to bring about cost savings amounting to US$1 billion
a year. Microsoft would also be able to leverage on Yahoo’s existing technologies and
cut back on some capital-intensive projects such as the building of massive data
centres.

Though Microsoft initially pursued the deal believing that it would help it enter the
lucrative online advertising market, the resistance of the Yahoo board was proving
difficult. Many Microsoft shareholders were displeased at the company’s attempt to
diversify its business. Whilst diversifying would theoretically reduce risk to Microsoft
and, by extension, to its stakeholders, diversification was something its shareholders
could potentially do more effectively on their own.

The protracted battle with Yahoo eventually took its toll on Microsoft, with its share
price falling substantially over the 6 month period following the takeover offer, from
US$30.45 per share to less than US$26 per share.

Yahoo’s Resistance

In spite of the benefits of the merger and overwhelming positive shareholder

sentiment towards the merger, Microsoft’s takeover attempt met with strong
resistance from Yahoo executives. Even after Microsoft sweetened the deal by raising
its offer to $33 per share, Yahoo executives insisted on a minimum asking price of
$37 per share, which was viewed MicroHoo!: The Attempted Takeover of Yahoo! By
Microsoft 187 as being absurdly high. Given that the 52-week high at that point in
time was $33.63, an offer of $37 would represent a 93 per cent premium over
Yahoo’s closing price as at 31 Jan 2008 ($19.18). They went on to enact a
controversial severance plan and pursued alternative tie-ups with Google and AOL in
an effort to put a stop to the takeover by Microsoft.

Yahoo executives cited regulatory hurdles, pricing and strategic issues,

undervaluation of Yahoo, and the loss of human capital and impact on employee
morale in defence of their actions.

CEO Jerry Yang expressed concerns over potential regulatory hurdles that could
delay or even squash the merger with Microsoft, leaving Yahoo high and dry should
they agree to the deal and move toward it, only to subsequently have it fall through.
The pricing of the deal was also of concern to Yahoo executives. Microsoft’s original
bid was half cash and half stock. As Microsoft’s share price dropped with the
announcement of the takeover bid, so too did the value of the deal. Yahoo was also
wary of being acquired by a much larger firm with little relevant expertise in its field.
Despite its poor recent performance, Yahoo continued to remain profitable. The same,
however, could not be said for Microsoft’s loss-making internet division and
comparatively low share of search queries (9.9 per cent compared to Yahoo’s share of
16.3 per cent in April 2009).

Another disincentive for Yahoo to agree to the merger is the perceived undervaluation
by Microsoft, as vehemently argued by CEO Jerry Yang. Sandeep Aggarwal, an
analyst with financial-services firm Collins Stewart, estimated that if Microsoft paid
US$15 billion for Yahoo’s search operation and US$3 billion a year to run ads on
Yahoo Web pages, such a deal could add up to US$9 a share to Yahoo’s stock price –
well north of Microsoft’s last offer of US$33 a share.

Concerns about lowered employee morale and the loss of human capital were also
cited, as a merger with Microsoft would undoubtedly see a large reduction in Yahoo’s
workforce as similar projects and departments were combined.

On a more personal note, CEO Jerry Yang’s emotional attachment to the company he
co-founded, his deep-seated hatred of Microsoft, and even perhaps his hope to
establish his legacy as an Internet visionary, also played a part in the decision to
rebuff Microsoft’s takeover attempt.

The Reaction of Yahoo Shareholders

In light of Yahoo’s recent poor performance, many shareholders saw Microsoft’s

offer as a good way to cash out on their investment, and thus were baffled by Yahoo
executives’ continued resistance to accepting the offer.

In the wake of the failed merger attempt, many shareholders filed lawsuits against
Yahoo for breach of fiduciary duties. In mid-2008, Carl Icahn, who held about 5 per
cent of Yahoo stock, initiated a proxy fight to unseat all of the existing board of
directors. However, even in light of perceived executive incompetence, diminishing
shareholder value and widespread shareholder dissent, it is often difficult to replace
the board of directors in a large public company like Yahoo. With one of Yahoo’s
largest and most influential shareholders backing the existing board, Mr Icahn finally
dropped his proxy bid in July 2008 in exchange for three seats on Yahoo’s expanded
board, not having been able to achieve his initial goals.
Looking Forward…

In November 2008, Yahoo announced it had begun a search to replace co-founder

Jerry Yang as chief executive. In January 2009, Carol Bartz was named CEO. Yahoo
and Microsoft subsequently reopened talks and inked a partnership in internet search
and advertising in July 2009. Yahoo’s performance continued to deteriorate, however,
with revenues decreasing year on year, cumulating in the firing of Carol Bartz, with
CFO Tim Morse stepping in as interim chief in September 2011.

Since October 2011, there have been talks of certain groups of private equity firms
looking to buy out Yahoo. In November 2011, it was reported that Microsoft had
renewed its interest in Yahoo.

On 4 January 2012, Scott Thompson, the President of PayPal, was named as the chief
executive of Yahoo. This was soon followed by the departure of Jerry Yang from
Yahoo’s board on 17 January. Analysts said that Yang’s departure might speed up
discussions to sell Yahoo’s prized assets, in particular, its 40 per cent stake in Alibaba
and its investment in Yahoo Japan. Whether or not any deal pans out remains to be
seen.

Discussion Questions

1. Did Yahoo’s management and board act in the best interest of shareholders when
rejecting Microsoft’s takeover offer?

2. Discuss the actions taken by Yahoo’s management and board to block the takeover
by Microsoft. Should such actions be prohibited?

3. In your opinion, do you believe that the offer by Microsoft is good for (a) the
shareholders of Yahoo, and (b) the shareholders of Microsoft?