Microsoft walks away from Yahoo deal

It’s all over the place — Microsoft has formally announced its withdrawal from the proposed Yahoo merger. This, after Microsoft upped its original bid of $31/share to $33; but Yahoo apparently wanted $37.

Microsoft backed out of the merger plan not because it cannot afford the asking price of $37/share (an additional $9 billion from the original price) but because Yahoo’s recent partnership with Google made things more complicated.

Evidently, Yahoo is on a self-destruct mode and Microsoft would have acquired a crippled company had it pursued a proxy fight and brought the offer directly to the shareholders, bypassing the board of directors.

Microsoft CEO Steve Ballmer explains the reason behind the withdrawal:

We regard with particular concern your apparent planning to respond to a “hostile” bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo! today. In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo! undesirable to us for a number of reasons:

• First, it would fundamentally undermine Yahoo!’s own strategy and long-term viability by encouraging advertisers to use Google as opposed to your Panama paid search system. This would also fragment your search advertising and display advertising strategies and the ecosystem surrounding them. This would undermine the reliance on your display advertising business to fuel future growth.

• Given this, it would impair Yahoo’s ability to retain the talented engineers working on advertising systems that are important to our interest in a combination of our companies.

• In addition, it would raise a host of regulatory and legal problems that no acquirer, including Microsoft, would want to inherit. Among other things, this would consolidate market share with the already-dominant paid search provider in a manner that would reduce competition and choice in the marketplace.

• This would also effectively enable Google to set the prices for key search terms on both their and your search platforms and, in the process, raise prices charged to advertisers on Yahoo. In addition to whatever resulting legal problems, this seems unwise from a business perspective unless in fact one simply wishes to use this as a vehicle to exit the paid search business in favor of Google.

This development will be interesting. While the potential Microsoft-Yahoo might make sense in the search and online advertising market, I’m glad this didn’t push thru. Still, there are some lingering concerns on what will become of Yahoo after this.

• Wall Street may not be as forgiving and bets are on the table that Yahoo’s stock would drop big time on Monday’s opening.
• Yahoo has already greased its reputation by conceding to Google’s paid click technology. By doing that successful paid search partnership with Google, it has effectively reduced the morale of hundreds of engineers who had worked on Yahoo’s Panama paid search system.
• Disappointed shareholders might bring Yahoo to court (a couple of lawsuits have already been filed against Yahoo in this matter). Once Yahoo’s share drops back to the pre-offer level (in the vicinity of $18), that would have effectively reduced potential shareholder value by as much as $15 per share. That’s a 45% loss on share value!

I have this gut feeling that this move could be a strategy from Microsoft’s end. If they move away from this offer, Yahoo is already bruised. Its market value will eventually level off and it will not be anywhere near the $33 Microsoft if offering. It might even drop to half of that.

There could be chaos and finger-pointing. Yahoo could slide down further against Google. After the dust settles, Microsoft could come back to the table with yet a new offer; but this time, it won’t be on a silver platter. The coming months will be as exciting (or gut-wrenching) as the last 3 months, depending on which angle you’re taking.