Investor urges Yahoo! to sell to Microsoft for upfront price of US$15bn

10 Dec 2008

One of Yahoo!’s largest shareholders, Ivory Investment Management, has called for a salvage deal with Microsoft and urged the board not to miss another value maximisation opportunity.

It was founder Jerry Yang’s failure to grasp Microsoft’s original US$42.2bn offer that led to investor Carl Icahn leading a shareholder revolt and installing himself and allies on the Yahoo! board, eventually resulting in Yang’s resignation in recent weeks.

Microsoft has since stated it will not be pursuing an acquisition of Yahoo!, instead revealing plans to focus on its own internet growth strategy.

Ivory Investment Management LP – which has 21.4 million shares, or 1.5pc of shares outstanding – today proposed in a letter to Yahoo!’s board of directors urging a salvage deal with Microsoft.

Noting Microsoft’s renewed interest, Ivory proposed that the company sell its search business to Microsoft, with Microsoft becoming the search provider for all Yahoo! properties.

Under the Ivory proposal, Microsoft would own and operate the combined search platform, with Yahoo! becoming an affiliate that retains 80pc of the revenue generated through searches on its own site. Finally, Microsoft would become the search engine for Yahoo!’s existing search affiliates.

“We believe a search deal with Microsoft could deliver value to Yahoo! shareholders of US$24-29 per share, or more than double yesterday’s closing price of US$12.19,” Ivory stated.

Ivory said in its letter that it believed Yahoo! could “receive more than US$15bn upfront from Microsoft for its search business and increase EBITDA by more than US$500m per annum.”

On an after-tax basis, Ivory said: “The US$15bn payment from Microsoft would be US$9bn for Yahoo shareholders, leaving Yahoo with US$21.2bn of cash and investments (up from US$12.2bn today) and annual EBITDA of US$2.4bn (up from the midpoint of current guidance of US$1.9bn).

Applying a 5x EBITDA multiple on the ‘new Yahoo!’ would result in a value of US$24 per share. If Yahoo were to go a step further and deploy the US$9bn in new cash for its own shares at a US$16 offer price, it could reduce its share count by 40pc, which would leave the remaining shareholders with a stock approaching US$30 per share (close to the original bona fide bid from Microsoft).

Noting that Yahoo! and Microsoft each may be spending well over US$1bn a year on their respective search businesses, Ivory said that combining the two could save US$800m in duplicate operating costs. In addition, due to the increased economies of scale in the search business, Ivory believes that the combination could increase total search revenues by at least 20pc or US$500m per year.

Ivory stated that its assumptions and estimates were based on publicly available data and statements from both companies.

“Even accounting for a reasonable margin of error in our estimates and assumptions, there is no question the proposed deal would significantly increase shareholder value (up to a 140pc increase compared to the current trading price).”

Ivory noted that both companies need to act now because they continue losing ground to Google, and that “it is widely acknowledged that neither company has kept pace with Google’s innovation and investment spending.

“This deal would offer Microsoft the unique opportunity to immediately gain critical mass to better level the playing field with Google, while it would simultaneously allow Yahoo! to both receive a sizable upfront cash payment and increase its prospective cash flow,” Ivory said.

By John Kennedy