What's Behind Yahoo's Rejection of Microsoft Bid?

Yahoo's rejection of Microsoft's acquisition bid is likely a negotiating strategy to elicit a higher offer and shouldn't be seen as an attempt to resist a deal at all costs, according to analysts.

Neither Microsoft nor Yahoo has many options to improve their position in online services and advertising, and combining forces is their best bet against common rival Google, analysts said.

"It's part of a larger negotiation that's occurring. Clearly, Yahoo should be and is seeking a higher bid, and this is part of that process," said Clayton Moran, a financial analyst with Stanford Group.

Yahoo is unlikely to find a company willing to bid as much as Microsoft for it, while Microsoft will not be able to attain its Internet goals by acquiring a company other than Yahoo. "While they need to negotiate and go through the process, at the end of the day this deal will happen," Moran said.

Yahoo today rejected Microsoft's bid, saying it undervalues the company. Microsoft offered to pay $31 per share for half of Yahoo's outstanding shares and 0.9509 of a Microsoft share for the other half.

At the time of the offer, Microsoft's stock stood at $32.60 and the bid was valued at $44.6 billion, a 62 percent premium over Yahoo's stock price at the time. However, the bid's value has dropped with Microsoft's sliding stock price, which at press time was $28.10. At the same time, Yahoo's stock price has risen from a close of $19.18 on the day before the bid to $29.75 at press time.
Bid Predictions

Moran predicted that Microsoft will adjust its offer so that it ends up at $35 per share, probably increasing the fixed cash portion and reducing the variable stock portion so that value is less vulnerable to Microsoft stock fluctuations. A $35-per-share offer would be a midpoint between the original bid and the $40 per share Yahoo is reportedly seeking.

"We continue to view a Yahoo sale to Microsoft as the most likely outcome," Citigroup financial analysts wrote in a note published Sunday after press reports over the weekend that Yahoo would reject the Microsoft bid. The rejection isn't surprising, but rather consistent with Yahoo's board job to "extract maximum value" for shareholders, the Citigroup analysts wrote.

Yahoo has reportedly held talks with Google and AOL to explore alternatives to a Microsoft acquisition. One scenario being floated would be for Yahoo to outsource its search advertising business to Google, while another, reported Monday by The Times of London, has Yahoo and Time Warner's AOL discussing a possible merger.

However, neither option would match the potential benefits of an acquisition by Microsoft, Moran said. "A combined Yahoo-AOL wouldn't be particularly strong, and Yahoo's stock wouldn't react favorably to that deal," Moran said. A search partnership with Google would boost Yahoo's revenue but it wouldn't address larger problems within the company, he said.

For Moran, if Yahoo has approached AOL, it has done so probably to send a message to Microsoft that it has other options and that Microsoft has to sweeten its offer. Meanwhile, Google's intervention is probably directed at complicating and lengthening the negotiation process between Microsoft and Yahoo, and thus delaying the formation of a stronger rival, Moran said.

While merging with AOL is unlikely to give Yahoo the boost it needs, such a deal would probably be more palatable to Yahoo's management, because Yahoo would be the strongest party in the fusion, according to industry analyst Greg Sterling of Sterling Market Intelligence.

"Yahoo sees its own demise in a Microsoft acquisition. My sense is that Yahoo's management believes that Yahoo's soul wouldn't survive as part of Microsoft," Sterling said.

At this point, the situation is very complicated for both Microsoft and Yahoo. If Yahoo is intent on fending off Microsoft's advances at all costs, Microsoft could opt to walk away empty-handed and face a public embarrassment, or attempt a hostile takeover, which could alienate and scare away Yahoo employees it would want to retain, Sterling said.

At the same time, Yahoo can't simply wave away a generous Microsoft offer if it doesn't have an alternative to it, Sterling said. "There is a great deal at stake for both sides, and it's very complicated," he said.

Microsoft declined to comment about Yahoo's rejection. AOL didn't immediately reply to a request for comment about its reported merger talks with Yahoo.