Microsoft threatens to turn Yahoo bid hostile

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Its patience running thin, Microsoft Corp. said Saturday it would turn its $40-billion bid for Yahoo Inc. hostile and probably lower its offer if the companies don't reach a deal within three weeks.

Microsoft vowed to nominate a slate of Yahoo directors who support a takeover if the deadline isn't met.

The world's biggest software company also went out of its way to quash Wall Street speculation that it would raise its 2-month-old offer to seal a deal.

"If we are forced to take an offer directly to your shareholders, that action will have an undesirable impact on the value of your company from our perspective which will be reflected in the terms of our proposal," Microsoft Chief Executive Steve Ballmer wrote in a letter sent to Yahoo's board Saturday.

Yahoo had no immediate response. A person close to the company said its board was reviewing the letter.

Although managers from the two companies have met twice since Microsoft announced its offer in early February, Ballmer complained in his letter that the Yahoo side hadn't been authorized to negotiate. Instead, Yahoo has been trying to work out an alternative alliance with the likes of News Corp., AOL parent Time Warner Inc. or Google Inc.

Microsoft could launch a tender offer to buy shares directly from investors, but Yahoo has a "poison pill" takeover defense that empowers the board to make such a campaign prohibitively expensive.

For that reason, executives involved in the fight have pointed to a proxy battle to elect directors as the most likely escalation if Yahoo doesn't accept Microsoft's bid or secure a comparable offer from another party.

Redmond, Wash.-based Microsoft has pursued Yahoo for more than a year, arguing that combining their consumer services and Internet advertising efforts would provide the best challenge to Google, which dominates search-based advertising and is moving rapidly into new areas.

Yahoo has been ceding market share to Google, though it continues to lead in displaying graphic advertising.

Sunnyvale, Calif.-based Yahoo collaborates with Microsoft on some fronts, but it has sought to remain an independent company.

Executives there say Microsoft's corporate culture and dependence on sales of Windows and Office software, which are growing more slowly than Internet-based services, make it a poor fit.

Since Feb. 1, when Microsoft went public with its cash-and-stock offer, then worth $44.6 billion, most analysts have believed the 62% premium to Yahoo's stock price at the time made an eventual union inevitable. Microsoft's subsequent stock decline has reduced the offer's value by about $5 billion.

But Ballmer argued in his letter that Yahoo's fortunes have fallen even further in the last two months. He noted that the economy has weakened, the stock market has slid and Yahoo's share of the search market and Web traffic has shrunk.

Yahoo also has enacted an employee-payout plan that would be triggered by a change in ownership, making an acquisition more costly.

"By any fair measure, the large premium we offered in January is even more significant today," Ballmer wrote. "We believe that the majority of your shareholders share this assessment, even after reviewing your public disclosures relating to your future prospects."

Anthony Valencia, an analyst with Microsoft investor Trust Co. of the West, said Yahoo's worth hadn't changed significantly, but it was hurt by its inability to drum up merger interest elsewhere.

"The bankers shopped it right away to everybody," he said. "If there was going to be an alternative bid, it would have happened already."

Yahoo's chief public argument that Microsoft is bidding too low has relied on projections that Yahoo can nearly double operating cash flow over the next three years to $3.7 billion.

"Yahoo is positioned for accelerated financial growth," Jerry Yang, Yahoo's chief executive, said in a statement last month.

"We have a powerful consumer brand, a huge global audience and a highly profitable operating model."

Yahoo has argued that it is worth $40 a share, well above the $31 Microsoft is offering in the cash portion of its bid.

Valencia noted that the three-week deadline gives Yahoo until shortly after it is scheduled to announce quarterly financial results.

Missing Wall Street's expectations could further weaken the company's bargaining position.

"It's kind of hard to figure out any scenario where Yahoo reports really strong earnings," Valencia said. "What are shareholders going to say if it's a less-than-stellar quarter and the Microsoft offer might go away?"

With the timing of the deadline and the threat of a lowered price designed to put maximum pressure on Yahoo, analysts were divided Saturday over whether Yahoo would capitulate or commit itself to fighting Microsoft in a proxy battle.

Microsoft is best positioned for such a contest, analysts said, but the prolonged acrimony would make an eventual combination of the two businesses more difficult to execute.

joseph.menn@latimes.com

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