Eighteen months ago Yahoo (YHOO) management rejected a $33 per share, $47.5 billion cash takeover offer from Microsoft (MSFT). Today the two companies have announced a search partnership that makes Microsoft’s Bing the default search engine on Yahoo and gives Yahoo no cash upfront for the privilege. This story is likely one of the worst executive management screw-ups in U.S. corporate history.
Yahoo shares had traded up to $17 each on anticipation of a deal with Microsoft but are trading down sharply today after the actual terms were announced. Yahoo will receive 88% of search revenue, while Microsoft will keep 12% for providing its technology. Yahoo saves money by not having to run its own search technology.
Who wins with this deal? Both companies, but Microsoft more so. Bing instantly increases its global market share from 6% to 15% by being incorporated into Yahoo’s sites. That still pales in comparison to Google’s 81% global share, but there is not much more room left to conquer now. Microsoft still makes some money here, even only keeping 12% of revenue, because market share has risen by 150% overnight.
Yahoo estimates that its annual operating cash flow will rise by $275 million from this deal, but it will take two years to be fully implemented. At their current valuation, that means about $3 per share of value creation, a far cry from the $14 of value creation ($33 cash versus $19 stock price at the time) that was offered by Microsoft and subsequently rejected as “undervaluing the company.”
And remember, these numbers are Yahoo estimates so they are going to be overly optimistic. A lot can change in 24 months, which is how long they think it will take to revamp these operations and integrate both companies into this new search structure.
Does this deal hurt Google (GOOG)? Not really, in my view. Do they care who has the 19% global search market share that does not flow through Google sites? Probably not, unless they really think Bing is so good that it will lure search queries away from them.
Given Microsoft’s history on the web, and with search products more specifically, it is hard to fear Bing, even if it has Yahoo as a partner now. Aside from Xbox, Microsoft has had little success diversifying away from Windows based operating systems and office software products. Putting two mediocre online players together is unlikely to have a dramatic effect on the industry landscape, although it will save each some resources.
As for the stocks, Peridot Capital has small positions in all three. Microsoft appears the most attractive at current prices, as Google is approaching fair value. Yahoo is less appealing now that an outright takeover by Microsoft is less likely. They could possibly come after the rest of Yahoo at some point in the future, but owning the stock for that reason solely is not very intriguing.
Full Disclosure: Peridot Capital was long shares of GOOG, MSFT, and YHOO at the time of writing, but positions may change at any time.