Wade Armstrong

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Yahoosoft — Where does that $45B Number Come From?

Posted Saturday February 2, 2008 in Business

Microsoft’s proposal to acquire Yahoo for $45 billion is both unexpected and widely-foreseen. Pundits have, for some time now, suggested that might be a reasonable course of action. But the purchase price is clearly aggressive, at $31/share for a stock that had closed at under $19 the day before. In fact, as Jupiter’s Michael Gartenberg puts it, this proposal looks more like Microsoft is saying “Dear Yahoo Shareholder: How would you like to get Yahoo’s share price from six months ago back, tomorrow?” Where’s the logic behind this price?

Where Yahoo Was Six Months Ago

Six months ago, Yahoo had just launched projet Panama, an improvement to its in-search text ads, and a restructuring, featuring layoffs. Investors anticipated that these two would, together, bring an increase in market share and in profitability. Well, neither of those happened. Would Microsoft’s acquisition help turn the clock back to the earlier state of hope? Well, to some extent. Microsoft, after all, promises “operational efficiencies”, corporate-speak for more layoffs. So headcount would go down, but would the acquisition make Panama work better? Certainly not in the next six months, which was the outlook the earlier price was based upon! So where could the rest of the value come from?

Search Market Share

Microsoft’s Don Dodge prices 1% of search share at $1B; HipMojo’s Ashkan Karbasfrooshan says “more like $750mm”. With 19.9% share per Neilsen/NetRatings and 23.7% share per comScore, this values Yahoo’s search alone at between $14.9B and $23.37B. Dodge further thinks that Google’s leadership means that 1% of its search business is valued at $3B. If you figure MSN/Live’s share at about 11%, and assume that the combined entities will hold about 31% share of search (vs. Google’s 57%), then figure that you can value that combined juggernaut at $1.5B per 1% share of search, then you can easily value search alone at $46.5B — enough to cover the cost of the acquisition.

Yahoo’s Other Properties

With a market cap of $25.5B at the pre-offer close price, the market is valuing Yahoo’s non-search assets — such as Mail, News, Finance, and Music — at between $1.3B and $10.6B. Given that Fox’s Murdoch recently bought Dow Jones for $5.6B, News and Finance alone can be valued at this point.

Yahoo’s Mail is the dominant Webmail player, with more than 56% of the market. Mail has got to be valuable for both its “stickiness” and its advertising inventory. With Hotmail thrown in, Microsoft totally dominates Webmail — again, this has to be of some value.

If you value Yahoosoft’s combined search at $30B, then Microsoft gets all this content and dominance in mail for, at most, $15B. But wait, there’s more.

Silverlight

There’s an interesting line in Microsoft’s letter to Yahoo shareholders:

Emerging user experiences: Our combined ability to focus engineering resources that drive innovation in emerging scenarios such as video, mobile services, online commerce, social media, and social platforms is greatly enhanced.

I suspect this is code for Silverlight, Microsoft’s competition to Adobe’s Flash. Flash has become ubiquitous on the Web lately, powering embedded players and widgets everywhere. Flash Mobile is also an important tool on smartphones, and Flash even provides the user interface for some cell phones. Like Java a decade ago, Flash is a platform that threatens Microsoft. But how does Microsoft fight back? Silverlight has landed in the marketplace with an audible thud; it’s main application is on Microsoft’s properties. With this acquisition, Silverlight gets to be on Yahoo’s properties as well — a big increase in reach, and maybe a start to Silverlight catching on.

What’s Silverlight worth to Microsoft? Well, three years ago, Adobe acquired Macromedia for $3.4B. The two main products that have survived from that acquisition are the Web design application Dreamweaver and the various Flash products. When Adobe acquired GoLive in 1999, it didn’t have to break out the acquisition because it was “not material.” Since then, content management systems have only become more important, and Web design software less, so it’s fair to say that Dreamweaver probably also has a “not material” value. Flash, then, is fairly valued at at least $3.5B. Making Silverlight take off would reasonably have about the same value.

Access to Silicon Valley

One of the reasons that some folks think that this hostile bid will fail is Yahoo founder and current CEO Jerry Yang’s well-known distaste for Microsoft. It’s fair to say that Microsoft is both physically and philosophically distant from Silicon Valley. As much as Yahoo has failed to execute in the last decade, it is still a Valley insider. Buying Yahoo — and keeping it as a separate entity — could help Microsoft get access to more startups and more talent in the center of the US tech industry for years to come.

Put It All Together

It’s clear that there are many possible ways to come up with a $45B valuation for Yahoo. In fact, with all of these ways to put the number together, it sure looks like a higher valuation could work. But who would pay it? News Corp could use Yahoo to go with Facebook, but this deal is too rich for its blood. Some folks like GE for the white knight, others mention Comcast, eBay, and more. But who’s ready to pay this premium? I’m with the naysayers on this one… the price is just high enough to lock out most likely bidders, and just low enough that it might be smart over the long run.

Facebook in Retrospect

There were a lot of upturned eyebrows when Microsoft dropped $240mm into Facebook at an extraordinarily aggressive $15B valuation. But now it’s clear what the real purpose of that was: forestalling Yahoo’s acquisition of Facebook by driving the acquisition price higher than the few billion that Yahoo had already tried to buy the company at. Fifteen billion was just too rich for Yahoo’s blood; but buying Facebook would’ve made Yahoo appear to have a future and a strategy. After all, a big proportion of the drop from $34.07 as recently as October 29 to $18.87 the day before Microsoft proposed is the market’s doubt that Yahoo can execute going forward. Buying Facebook would’ve at least made it appear that Yahoo had a strategy and was executing on this; for an expenditure of literally about twenty cents per share, Microsoft forestalled this Yahoo share bump and made the company an acquisition target, not an acquirer. Murdochian indeed!