[Posted on April 18, 2008 - 5:17 PM]
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DiggInvestors were falling over themselves Friday trying to buy shares of Google Inc. [GOOG] after the online search firm surprised Wall Street with its first-quarter earnings report. But attention will quickly turn to rival Yahoo! Inc.'s [YHOO] first-quarter report scheduled for after markets close on Tuesday with its potential implications for the purchase price Microsoft Corp. [MSFT] may pay for the company.
"It's pretty much a foregone conclusion that Yahoo! has all the incentive imaginable to eke out a 'beat-and-raise' quarter," said David Garrity, analyst with Dinosaur Securities LLC in New York. "The reasons for it are obvious--you want to get Microsoft to raise its bid."
Yahoo! has said publicly that it is on track to meet its revenue guidance of between $1.28 billion and $1.38 billion, with adjusted Ebitda expected at around $425 million. Garrity said Google's strong financial performance increases the likelihood of Yahoo!'s revenue coming in at the upper end of the range, a result not necessarily beneficial to Microsoft.
"The fundamental conditions that Microsoft was hoping for--Yahoo! having a miss and the results deteriorating so they could lower their price--failed to materialize," he said. "It's certainly a situation now where unlike prior to the report from Google, time is not on Microsoft's side.
"These valuation gaps between the fundamentals and where the stock is trading are closing," Garrity added.
Google shares rose more than 20% to $541 Friday, while Yahoo! was up less than 2% at $28.50. Much of the strength in Google's revenue came from its international operations, which rose by 14% compared to the fourth quarter and 55% year-over-year. A strong report from Yahoo! could also hinge on its overseas numbers, Garrity said.
Yahoo!'s current guidance represents an 8.2% increase over the $1.18 billion in revenue reported in the first quarter of 2006 at the low end and a 16.6% increase at the high end. Sanford C. Bernstein & Co. LLC analyst Jeffrey Lindsay has said anything less than a double-digit increase would be viewed negatively by Wall Street.
While Yahoo! maintains the quarter in on track, weakness in the economy could still come into play. In a research report last week, Collins Stewart analyst Sandeep Aggarwal said the Sunnyvale, Calif.-based company is more exposed to the financial services sector than other do Internet companies because of its popular Yahoo! Finance site. He said industry contacts have indicated that mortgage, savings deposits and credit cards are the top three categories in the financial services vertical that are experiencing "massive cutbacks" in online advertising budgets.
"Though Yahoo! is very strong in the entertainment, sports and news verticals as well (which are counter cyclical), we think that the financial vertical could be a drag on Yahoo!'s Q1 earnings," he wrote.
Regardless of how Yahoo!'s numbers come out, the company has thrown a monkey wrench into Microsoft's efforts to acquire by floating the possibility of making a temporary agreement to outsource its search advertising to Google more permanent. The two companies agreed April 9 to a two-week trial to place Google's ads alongside its search results. But The Wall Street Journal reported on Thursday that early returns were positive enough for the companies to consider making the partnership more permanent.
Such an arrangement would benefit Yahoo!, as Google monetizes search results far better than Yahoo!. Citigroup Inc. analyst Mark Mahaney estimates that fully outsourcing search to Google could generate "well over $1 billion" in cash flow to Yahoo!.
But problems arise when considering the antitrust implications of combining the operations of the top two search players. Microsoft, hardly an unbiased observer, has estimated a definitive agreement between Yahoo! and Google would consolidate more than 90% of the search advertising market. But Sanford Bernstein's Lindsay quibbles with Microsoft's math, contending not only that outsourced deals typically do not count as market share, but the market share figure is closer to 32% if both search and display advertising worldwide are considered.
Still, any agreement the two companies reach would draw close regulatory scrutiny, which would get in the way of Microsoft trying to get a deal done as quickly as possible. While there's little question that Yahoo! is not keen on being swallowed up by Microsoft, there are thoughts that the courtship with Mountain View, Calif.-based Google serves as a bargaining chip designed to elicit a higher offer from Microsoft. Google is a willing participant because it makes money on the deal and isn't too interested in seeing Yahoo! and Microsoft become a more potent foe.
Most analysts still predict that Microsoft will get Yahoo!, though it may need to pay a higher price than the current $31 a share cash and stock offer (now valued at $29.77 due to a decline in Microsoft's share price). Dinosaur Securites' Garrity said Microsoft may need to offer $33 or $35 a share in order to get enough support from Yahoo! shareholders.
Microsoft on April 5 set a three-week deadline for Yahoo! to conclude an agreement or it would initiate a proxy contest to elect candidates to the Yahoo! board of directors. Microsoft also threatened to lower its offer price if it had to take more hostile actions. -- David Shabelman
Comments
From: David Shabelman,
There are any number of reasons why a Microsoft-Yahoo! combination makes sense. Though Google continues to take search market share away from both Yahoo! and Microsoft, combining the two operations gives them more of a fighting chance to at least battle it out with Google, particularly with Microsoft's money behind it. It can also sell search and display advertising together. And while Google has a daunting lead in search advertising, Yahoo! is tops in display advertising, an area with huge growth rates. Microsoft's own efforts at growing online advertising have been disappointing, which is why it is reaching out to grab Yahoo!
How Yahoo! benefits from an acquisition is pretty much a moot point. As a public company, Yahoo! is beholden to do what's best for its shareholders. Microsoft's $31 a share offer was a 62% premium to where Yahoo!'s shares were trading at the time it was made. Unless it can show shareholders it has a better option (something it is desperately trying to do) it will need to accept a deal or negotiate a better one.
Posted on:
April 21, 2008 12:32 PM
I don't get the merger -
The MSFT brand, among the most recognized in the world has produced a much smaller Internet user audience than Yahoo! As an investor, what I would like to know is a) If the MSFT brand is obviously weaker on the Internet than Yahoo's, then how would Yahoo! benefit? b) If MSFT nor Yahoo have the technology to beat Google, then what's the point of this deal? Aren't they both being cannibalize by Google? c) If the value is the Yahoo customers, why does MSFT have to spend billions of dollars to get customers and traffic that can easily migrate away?
Please explain this deal to me--
kb