DealBook: Limited Choices for Yahoo, Each One With Its Own Risks

Harry Campbell

Yahoo shareholders should brace themselves again for disappointment. While the board is seeking a deal for the company, Yahoo faces limited options — all with significant downsides and risks.

The cleanest transaction would be for the Yahoo board to sell the company outright in an auction. This, in theory, would give downtrodden shareholders a premium return — one that they have been hungering for since the board turned down Microsoft’s offer to buy the company at $31 a share in 2008. A full sale would also relieve the Yahoo board of the headache-inducing task of rebuilding the Yahoo business and hiring a new chief executive.

Unfortunately, the Yahoo board has apparently refused to solicit bids for a sale. The company hasn’t said why, but the most likely reason is that with the state the business is in, it is unlikely to get a price as high as Microsoft offered four years ago. (Yahoo shares closed Tuesday at $15.84) The Yahoo board simply does not want to face up to the fact that it was a mistake to spurn Microsoft’s offer.

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There are other reasons. Yahoo’s prize assets are a 43 percent interest in Alibaba, the Chinese Internet company, and a 35 percent interest in Yahoo Japan. A sale of Yahoo may prompt a change of control in Yahoo’s agreement with Alibaba’s shareholders, giving them a right to repurchase Yahoo’s stake in this Chinese asset, something they are salivating to do. So, a buyer of Yahoo may not reap the value of Alibaba, further diminishing what Yahoo could get in a full sale.

And frankly, there are not a lot of potential bidders for the entire company. An acquisition would cost more than $20 billion and represent a big turnaround project for any suitor. Yahoo’s outsourcing of its search engine functions to Microsoft also makes it hard for anyone other than Microsoft to take full advantage of Yahoo’s technology.

In the absence of a full sale, Yahoo has been soliciting proposals for a minority investment.

Two competing consortiums have submitted bids to make a minority investment in Yahoo, according to people briefed on the matter. Microsoft, Silver Lake and Andreessen Horowitz have submitted one bid, while TPG Capital has submitted the other. TPG is seeking to bring in Greylock Partners, a venture capital firm whose partners include a LinkedIn co-founder, Reid Hoffman.

The Microsoft/Silver Lake plan would have Yahoo sell its holdings in Alibaba and Yahoo Japan and pay out shareholders, as well as alter the board and appoint a new chief executive. The TPG plan contemplates something similar.

The problem with these plans is that they both would involve Yahoo’s borrowing billions to give shareholders something. The shareholder payout would most likely take the form of a share repurchase that would give the investing group about a 40 percent interest in Yahoo. Together with Yahoo’s co-founders, Jerry Yang and David Filo, the investing group would effectively control Yahoo. Some Yahoo shareholders — in particular, Daniel S. Loeb of Third Point, which owns about 5 percent of Yahoo — are likely to react strongly to this transaction. They would complain that control of Yahoo was being sold without a shareholder vote.

Yet what these plans offer is a way for Yahoo to acquire a management team. That is why the Microsoft/Silver Lake bid — with Marc Andreessen, the Internet wunderkind, on their side — is said to be favored by the Yahoo board and why TPG is trying to work with Mr. Hoffman.

The problem is that this is a high price to pay for a management team. Silver Lake and its partners would be looking to effect a turnaround of Yahoo’s core business akin to what Silver Lake did with Skype. But Yahoo’s public shareholders would be deprived of a significant part of any upside.

Simply selling Yahoo’s Asian assets is also not going to be cost-effective for Yahoo. That is because the other shareholders in Alibaba may have rights of first refusal that they will undoubtedly exercise if they can. No other suitor will bid because of this, meaning that the two Asian companies are in the driver’s seat for buying Alibaba at a low value.

This leads to the last option: Yahoo can remain wholly independent. The board would have to dig in and try to turn around the company and recruit a chief executive who can lead a Yahoo renaissance. Yet, the Yahoo board has had little luck with its last four chief executives and has been prone to making poor choices, the prime example being the rejection of the Microsoft offer.

The one wild card in all of this is Jack Ma, who wants to control the 43 percent of Alibaba held by Yahoo.

Mr. Ma’s problem is that the United States government would almost certainly act under the national security laws to block Alibaba’s takeover of Yahoo. Federal authorities have been applying these laws aggressively to block Chinese acquisitions, including the proposed acquisition of 3Com by the Chinese telecommunication manufacturer Huawei. Even if an election year were not approaching, a Chinese acquisition of one of America’s premier Internet properties is almost certainly a nonstarter.

Mr. Ma recognizes this. He doesn’t want Yahoo’s American operations, and he is said to be talking to the Blackstone Group, Bain Capital and other private equity firms about teaming up to buy the American operations, leaving Mr. Ma with all of Alibaba. Softbank might join this group to purchase the 35 percent of Yahoo Japan owned by Yahoo.

No matter what Yahoo does, Mr. Ma may decide to push for a full sale of Yahoo to his consortium or a third party. He doesn’t care who wins the bidding, because he would argue that a full sale would activate his right to repurchase Yahoo’s Alibaba stake.

Mr. Ma has reason to fear a minority investment in Yahoo, because it would take away the leverage he would have if he made a full bid. So, expect Mr. Ma to make a lot of noise if Yahoo goes the minority investment route.

All of this means that Yahoo is faced with a series of bad choices, with the board focusing on staying independent or taking a minority investment. The bravest and perhaps riskiest of the two is independence.

In either case, determining the fate of Yahoo is likely to be a messy business for some time.

It’s Time to Grade This Year’s Deals

The year is nearing its end, and it is once again time to reflect on the deal-making successes and failures of 2011. As in prior years, I’ll be doing my part here at Dealbook by awarding year-end grades. The A’s will go to deal makers who performed superbly and deals that succeeded spectacularly. The F’s will go to the year’s deal-making failures.

If you know of a deal that fits either category and would like to nominate it for consideration, please send an e-mail by Dec. 15 to dealprof@nytimes.com. Self-promotion is welcome, as are reasons why you think a deal or deal maker qualifies.

I’ll be posting the grades shortly thereafter.

Article source: http://feeds.nytimes.com/click.phdo?i=146afb02645cb7104d12eb58390e69ec