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Microsoft, Yahoo Seek Ways To Cooperate

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The Associated Press

Published: May 20, 2008

SAN FRANCISCO - Just two weeks after breaking off merger talks, Microsoft Corp. and Yahoo Inc. have been pulled back to the bargaining table by their fears about what might happen if they don't work out a deal.

For now, Microsoft and Yahoo are dancing around the edges as they explore possible business arrangements without melding the companies.

The notion of a half-baked deal did not excite investors Monday as they reacted to Sunday's news that Microsoft and Yahoo are talking again.
Yahoo shares rose 2 cents, to close at $27.68 on Monday, and Microsoft shares fell 53 cents, to close at $29.46.

Most analysts remain convinced the preliminary talks will culminate in Microsoft buying Yahoo for between $33 and $37 a share, a price that translates to $47.5 billion to $53 billion.

Microsoft and Yahoo issued statements Sunday acknowledging they have not ruled out the possibility of a merger even though they are not discussing one now.

Although their discussions fell apart this month in a disagreement over price, Yahoo and Microsoft have powerful incentives to reach a compromise in the next few weeks.

If Yahoo doesn't stop demanding $37 a share, its board could be overthrown in a shareholder mutiny led by activist investor Carl Icahn.

To pressure Yahoo into reviving the talks, he has nominated an alternate slate of 10 directors scheduled to stand for election at Yahoo's July 3 annual meeting. Icahn didn't respond to a request for comment Monday.

Meanwhile, Microsoft's unwillingness to pay more than $33 a share created an opportunity for its nemesis, Google Inc., to enter an advertising partnership with Yahoo.

"It's becoming pretty clear that Yahoo is either going to work something out with Microsoft or do a deal with Google," said Standard & Poor's equity analyst Scott Kessler. "If Yahoo winds up with Google after all this, it would be pretty damaging to Microsoft."

Microsoft began pursuing a Yahoo takeover in late January largely as a means to counter Google's dominance of Internet search and advertising markets.

After Microsoft pounced, Yahoo became more receptive to an idea that it had resisted in the past - allowing Google to show some of the ads alongside Yahoo's search results.

A two-week trial last month demonstrated Google's technology could help boost Yahoo's profit, and the two sides began exploring a long-term alliance. However, any partnership between Google and Yahoo likely would face antitrust obstacles because the two companies control more than 80 percent of the U.S. search advertising market.

A similar deal between Yahoo and Microsoft would not pose the same antitrust problems because Google still would control more than half the market.

"We believe that a core issue for Microsoft is to acquire Yahoo on friendly terms," UBS analyst Benjamin Schachter wrote in a research note Monday. "A near-term deal in search could act as an intermediate step that would go a long way toward testing the waters," Schachter wrote.

Redmond, Wash.-based Microsoft also might buy key pieces of Yahoo's online operations instead of doing a search advertising partnership or acquiring the entire company, Collins Stewart analyst Sanded Aggarwal said in a research note Monday.

He values Yahoo's search technology at $21 billion, its display advertising service at $14 billion and its Internet holdings outside the United States at $9.25 billion.

Yahoo Chief Executive Jerry Yang thinks that the Sunnyvale, Calif.-based company is on the verge of a turnaround that will prove it is worth more $50 billion.

Starting next year, Yang has promised that Yahoo's net revenue will increase by 25 percent annually - more than doubling its recent rate of growth.

However, Icahn, who owns a 4.3 percent stake in Yahoo, so far has indicated that he is not willing to wait until next year. Many other major shareholders also appear ready to back him up.

Kessler doubts that Yahoo will be able to placate its shareholders by entering into a partnership with Google, particularly if the alliance could hurt Yahoo in the long run by subverting its own technology in the critical search advertising market.

"It's almost a no-win situation for Yahoo because they aren't going to get sufficient time to prove they are worth $33 per share or more," Kessler said.

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