Decision Time For Yahoo

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The dust is settling on Microsoft’s $31 per share offer to acquire Yahoo, and the options left open to the company are fairly well understood at this point. There will almost certainly be no White Knight or other buyout offer coming to the table – the sorry state of the debt markets is assuring that.

Yahoo was hoping for a competing bid, any competing bid, if only to boost Microsoft’s offer to the $40 range. With no competing offer, Microsoft has no need to increase what they’ve put on the table. That means it’s decision time for the Yahoo board of directors.

They can take Microsoft’s offer. Or they can try to do a deal with Google to outsource their search advertising and boost cash flow. They can also do nothing, but that would likely result in a flurry of shareholder lawsuits for a breach of fiduciary duty. Doing nothing isn’t an option for Yahoo’s management and board.

As has been widely reported, Yahoo could increase its cash flow by an estimated 25% if it surrendered to Google and handed over its search advertising business. That could give them enough of an excuse to turn down Microsoft’s offer. To outsource search advertising to Google, though, would be a huge hit to Yahoo’s pride. It’s an implicit acknowledgment that the years of work that went into Yahoo’s Panama project to revamp their search advertising platform was not enough – they still can’t compete with Google.

Of course, the hit to Yahoo’s pride will be worse if they sell outright to Microsoft, the dreaded enemy of Silicon Valley.

It’s not clear that the DOJ would approve either deal, although on balance the Microsoft deal is probably more likely to create a competitive environment. Google could be a very dangerous company without any competition whatsoever in the search advertising space.

For its part, Google probably wishes Yahoo had put up a little more of a fight over the last couple of years and wasn’t in this position. They are making so much money in the current marketplace that anything that disrupts it is worrisome. Sure, getting Yahoo’s search business would be great – they take out a competitor and get more market share. But they would have to give Yahoo the lion’s share of gross revenue. And they are so dominant already that any further gains risks the attention of the U.S. and E.U. governments. A merger between Microsoft and Yahoo is a worse outcome, mostly because the sheer volume of searches and page views the combined company would control could actually produce a viable competitor.

The status quo suits Google just fine, which is of course why they are arguing for it. And this is where Google and Yahoo’s interests are suddenly in alignment. If for some reason the DOJ decides the Microsoft-Yahoo merger is a bad idea and gives it a thumbs down, then Yahoo can stay an independent entity (for now) and avoid those shareholder lawsuits (blame the government!). Meanwhile, Google can keep their money machine rolling.

Whatever happens, the salad days for Yahoo are long gone. 2008 will be the year Yahoo ceased to be one of the big independent Internet heavyweights. They’ll almost certainly become an operating subsidiary of Microsoft, or Google’s whipping boy. And if by some chance the government puts a stop to either deal, they’ll have a short reprieve before facing similar decisions next year or the year after. The world is an unforgiving place. Yahoo is cute, cuddly and likable, but they did not execute the way Google did. And because of that they are quickly turning into collateral damage in an epic war that is really just beginning between Microsoft and Google.

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