Tags: Yahoo (YHOO); Microsoft (MSFT); Google (GOOG)
February 5, 2008 — Special Edition…Part I (of II)
Big Techs — Toothless or Tigers
Special Editions are rare — this is the first from Daily Views. The primary conclusion from the biggest news last week, the hostile takeover of Yahoo by Microsoft, is that this is an event that will remain a serious presence in the financial media for weeks to come. It cannot help but exert influence on investment strategies that emerge, either from these electronic pages or others that subscribers read. We felt compelled to weigh in on this event.
The initial market euphoria seemed to view this takeover as a harbinger of more ‘tech deals’ in the near future. We disagree. This is an acquisition Microsoft had to make as technology goes from desk top to mobile. CEO Ballmer’s stated a Yahoo! merger a year ago failed. That timing might have produced more enduring expectations but to pull that trigger now is 100% defense, and an expensive defensive move at that.
The markets opened flat on Thursday, January 31st, and then shot up after Microsoft’s announcement. By Friday’s close, the Dow was up 2.4%, NASDAQ up 2.8%. Yesterday, the markets sold off a bit, possibly dampened spirits from underwhelming Super Bowl ads, though these indexes are still about 1% higher than pre-Microsoft news. Yahoo! rose to close at $29.33, up $0.95, or 3.3% from Friday’s close. It is significant that Yahoo! has yet to hit the $31 / share Microsoft bid.
Some of this uplift in the indexes represents nothing more complicated than ‘sellers’ fatigue. From the beginning of 2008 until the day before Microsoft’s announced hostile takeover of Yahoo, the S&P 500, a broader, market-value weighted index, declined by more than 11%, in less than a month from 2652 to 2349. As depressing to portfolio values as that may be, both Microsoft and Yahoo were performing well below market indexes, prior to January 31st.
Microsoft’s acquisition of Yahoo! provided a momentary antidote to this sellers’ fatigue. In its aftermath, overhanging uncertainty now aptly describes the next year or so while regulators in the USA and Europe review this proposed transaction. The USA regulatory landscape may be resolved this year, however, Europe, where Microsoft has some challenging history, is unlikely to rule on this until 2009. Meanwhile, there are some genuine operating impediments to this merger.
Here is a link to the New York Times technology blog, that points out three practical hurdles ~ http://bits.blogs.nytimes.com/2008/02/01/microsoft-is-building-a-spaceship-out-of-spare-parts
1. “Microsoft and Yahoo have taken different technical approaches to search. .. merging the best from both would take years. Would Microsoft throw out its multibillion dollar investment in search?”
2. “Advertising systems are more complex than search engines…combining algorithms to pick the best ads to show with a real time auction among advertisers. Yahoo’s Panama system is weak, a year late and over budget. Combining it with MSFT’s Ad Center will cause a lot of pain.”
3. “Portals and Applications — merging instant messaging systems might create a rival to AOL’s AIM. The race for applications is wide open for products like Google Docs. If this deal can get Microsoft to separate this effort from Office, it could give Microsoft an advantage.”
Finally, there is the matter of valuation of the Yahoo takeover price itself. At a purchase price of $31 per share, Microsoft is proposing to purchase Yahoo at 61 times 2008’s projected earnings. This works out to a transaction value of $43 billion. The table below provides a history of Yahoo’s market value since it went public in April 1996. To place Yahoo’s 1999 valuation into perspective, that was in the middle of the stock market bubble inflating — from September to December 1999, the NASDAQ index advanced a stunning 48% (from 2746 to 4069)
There is some other market history to help shape an investment point-of-view, however; the merger of AOL and Time Warner. Though that transaction was consummated in 2001, the commercial terms were set in the fourth quarter of 1999 — or right in the middle of a NASDAQ stock market feeding frenzy. Here is a link to refresh collective memories ~ http://www.referenceforbusiness.com/businesses/A-F/AOL-Time-Warner.html
The AOL bought Time Warner for $163 million. At the time, the combined enterprise had earnings of $1 billion, hence, a multiple of 163 times. As painfully recalled in the linked historical article, two years later, the enterprise took a $54 billion write-off, or one-third of the purchase price. Given the infrastructure obsolescence highlighted by the New York Times tech blog, write-offs of a combined Microsoft-Yahoo seem inevitable, though probably not of a similar magnitude (i.e. one-third of $43 billion = $14 billion).
Had Microsoft pursued this acquisition when Yahoo was selling in the vicinity of $8 – $9 / share, which it was, not too long ago, that might have demonstrated the Microsoft perspicacity of the past. But, like many huge companies, Microsoft got to a point where there was more to protect than gain. Similarly, Yahoo should have bought Facebook when it could, which it didn’t.
The only observation that is inescapable is that of a couple of tired old companies trying to recapture the limelight, including the buzz, of days gone by. It’s not going to happen. It reminds us of a rock concert this summer that featured the popular groups of days-gone-by…the Platters, the Coasters and the Four Tops. They provided some great memories, but many years later, the performances are just not the same.
The best conclusion to offer individual investors at this time is expect nothing definitive about this merger for a year, and to channel investments to Alternatives other than the Big Techs like Microsoft, Google and Intel. Research studies are abundant confirming that over the long term, all stocks gravitate toward a leading 12 months Price-Earnings multiple of 16…which is precisely where Yahoo was headed prior to Microsoft’s hostile takeover bid.
It is doubtful another suitor will emerge to surpass Microsoft’s 61-times-EPS purchase price, which begs the unspoken question in the market place and in the financial media: Other than the $31 per share purchase price, sometime this year, what’s in this for Yahoo’s shareholders and is this a return worth waiting for…?
In our next issue, we will provide a review of the Model Portfolio which illustrates some stocks that comprise a sampling of Alternative Investments.
Let us hear your thoughts below: