Pressure is mounting on Yahoo

Times Staff Writer

He fended off Microsoft Corp.'s takeover bid, at least for the moment. Now Yahoo Inc. Chief Executive Jerry Yang needs to prove that he made the right decision.

Yang and his team were "elated" when Microsoft withdrew its 3-month-old offer Saturday, said one person close to Yahoo management, even after the software giant expressed willingness to add about $5 billion to its $42-billion bid.

But their jubilation might be short-lived.

Yahoo's shares are expected to plunge today, as investors punish the company for pushing away a deep-pocketed suitor willing to pay a big premium. Microsoft said Saturday that it had failed to agree with Yahoo on a price and ruled out waging a proxy fight.

"It's not going to be a good day for any of us," one major Yahoo shareholder said.

Yang has vowed that Yahoo is viable as a stand-alone company. But already, some shareholders have sued Yahoo for rejecting the initial cash-and-stock offer, which was worth $44.6 billion but fell in value with Microsoft's stock price.

Sunnyvale, Calif.-based Yahoo is pursuing a limited advertising partnership with Google Inc. and a tie-up with Time Warner Inc.'s AOL, people familiar with the situation said. It also continues to promote its turnaround strategy amid falling confidence in Yahoo's long-term prospects and management after two years of eroding financial results. Yang planned to hold a conference call with Yahoo's senior executives Sunday afternoon.

Google and AOL declined to comment.

Now that Microsoft has withdrawn, Yahoo management will have to deliver a "transformational" partnership or deal, Needham & Co. analyst Mark May said Sunday.

A Yahoo spokeswoman said the company was "exploring all strategic options to maximize value for shareholders."

Microsoft Chief Executive Steve Ballmer said in a letter to Yang on Saturday that the Redmond, Wash., company had offered to raise its bid to $33 a share, from $31, which would have represented a 70% premium over Yahoo's stock price at the end of January when Microsoft made its offer. After Yahoo requested at least $37 on Saturday, Ballmer said, Microsoft decided to walk away.

Many Yahoo shareholders favored a deal at about $34 a share. Even those who wanted more still supported a Microsoft takeover, analysts said.

"What we really need to see is the Google deal. A lot hinges on how good the Google deal is," said the major Yahoo shareholder, who asked not to be identified in order to continue discussions with both companies.

Yahoo is working intently to clinch the deal, which would significantly boost its cash flow and allow it to invest more in its own online advertising system. A two-week test in which Google delivered ads on a small portion of Yahoo Web searches performed "phenomenally," a person familiar with the situation said. Google earns about 60% to 70% more on average for every search than Yahoo does.

Such a partnership between the two search leaders probably would attract intense scrutiny from regulators. The Justice Department has already begun to look into the relationship.

In the absence of a Google deal, investors are bracing for a steep decline in Yahoo stock. Shares, which have risen nearly 50% since Microsoft made its offer, could lose most of that gain.

Analysts have estimated that Yahoo shares would fall to $20 to $25 if Microsoft abandoned its bid. They had risen 7% to $28.67 on Friday in anticipation that a deal with Microsoft was going to be sealed over the weekend.

Laura Martin, an analyst with Soleil Securities, predicted that investors would knock off 28% today alone, driving Yahoo shares down to about $20.

"The market is going to tell everyone [today] just how credible Yahoo's long-term targets are," said Anthony Valencia, an analyst at institutional investor TCW Group in Los Angeles, which owns Yahoo shares.

Dissident Yahoo shareholder Eric Jackson said Sunday that he planned to rally shareholders to withhold their votes from all Yahoo directors at the company's annual meeting, which has not yet been scheduled. Jackson leads a group of about 140 shareholders who together own 2 million Yahoo shares.

Such threats could mean a bumpy ride ahead for Yahoo's board and management. Analysts expect a barrage of lawsuits in coming weeks. Shareholder pressure could still force Yahoo back to the negotiating table with Microsoft. That was the tactic employed by Oracle Corp. last year in its ultimately successful bid for BEA Systems Inc.

Yang will have to make something happen fast to prove to shareholders that Microsoft undervalued Yahoo. His argument: Yahoo has gotten leaner, more focused and better able to execute. He points to recent quarterly earnings, which beat analyst estimates by a little, as a sign that Yahoo is on the right path.

"They are beginning to turn the ship around," Canaccord Adams analyst Colin Gillis said.

Sanford C. Bernstein analyst Jeffrey Lindsay says Yahoo could be worth as much as $37 a share if it partners with Google, depending on how the deal is structured and if it reduces head count. Without Google, its value would drop to about $25 a share, Lindsay said.

Not everyone is so sanguine about Yahoo's prospects in an economic slump and softening advertising market. Yahoo executives told investors in March that by improving display ad services and expanding in cellphone programs and other new areas, revenue could grow from an estimated $5.7 billion in 2008 to $8.8 billion in 2010, well above Wall Street forecasts. But analysts did not raise their forecasts, reflecting broad skepticism that Yahoo can deliver on its promises.

If Yang's efforts fail, the company's stock could sink even lower, inviting less attractive offers that would be more difficult to fend off.

Not everyone views Google as Yahoo's savior. Shareholders may resist a plan to outsource such a crucial part of Yahoo's business to its archrival, which has grown stronger while its two main competitors were distracted with merger talks.


Times staff writers Michelle Quinn and Joseph Menn contributed to this report.

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