Yahoo shares take a hit on Monday

IDG News Service — Mon, 05 May 2008 15:48:57 -0700

Yahoo's stock lost significant value on Monday, the first day of trading after Microsoft's decision over the weekend to give up on acquiring Yahoo.

Yahoo's shares closed down 15 percent at US$24.37, after dropping as low as $22.97 during the day.

While Wall Street seemed displeased that Yahoo and Microsoft didn't consummate their merger, at least Yahoo's shares didn't retreat to their $19.18 pre-acquisition-bid price.

"It was expected that the stock would be down meaningfully today. It's also not surprising the stock is up fairly substantially from where it was prior to the offer's announcement," said financial analyst Troy Mastin of William Blair & Co.

As Mastin sees it, the stock managed to avoid a freefall to its pre-bid levels because Yahoo's management has outlined plans that could increase the company's value.

"This potential transaction seems to have catalyzed Yahoo's management team to try to unlock some shareholder value or some hidden profitability in their business model they've been slow to try to unlock before," Mastin said.

One such move could be the deal that Yahoo is reportedly trying to cut to outsource part of its search advertising business to Google. That would significantly boost Yahoo's revenue and cash flow. Another value-creating possibility would be the re-emergence of Microsoft as a Yahoo buyer in the coming months, he said.

It's hard to know if an outsourcing deal with Google would be a wise move in the long term, since it would give Google more power in search advertising, a market it dominates. As such, the Google deal puts Yahoo in a challenging position, having to balance the short-term interests of its shareholders with long-term considerations, Mastin said.

The Google deal could potentially give Yahoo the lift it needs to push its share price to $33 or higher, said Mastin, who rates Yahoo's stock as "market perform," meaning he expects it to perform approximately in line with the broader market over the next 12 months.

Microsoft's last offer for Yahoo was $33 per share, or about $5 billion more than its original offer, but Yahoo declined it, saying it wanted $37 per share, according to Microsoft.

Yahoo did a limited, two-week test run of Google ads in April, but hasn't disclosed the results. Without that knowledge, it's tough to say whether Yahoo did the right thing in rejecting Microsoft's offer, Mastin said.

Yahoo's stock got a boost after Microsoft announced its original $44.6 billion acquisition bid on Feb. 1, rising from $19.18 the day before the offer to more than $30 during intra-day trading, although its highest closing price was $29.98 on Feb. 14. Yahoo's board formally rejected Microsoft's original bid on Feb. 11.

Derek Brown, a financial analyst with Cantor Fitzgerald, said what happens with the stock now "depends a lot on execution by management and ongoing developments with its strategic direction."

He agreed that while the Google deal offers short-term potential for benefits, "it raises meaningful longer-term questions about Yahoo's strategy and opportunity."

Brown, who maintains a "hold" rating for Yahoo, believed that the acquisition by Microsoft was more likely to happen than not.

Meanwhile, on Sunday, Citigroup financial analyst Mark Mahaney downgraded Yahoo to "sell" after Microsoft withdrew its bid.

Mahaney sees three scenarios for Yahoo. The first and most likely, at a 45 percent probability, is that Yahoo goes back to "business as usual," in which case he would value its stock at $22 per share.

The second scenario, with a 40 percent probability, sees Yahoo entering into a "major strategic alternative," such as the Google outsourcing deal, a partnership with AOL or MySpace and a sale of Asia assets, and would put the stock at a $26 value in his view.

The third and least likely scenario, at 15 percent probability, is that Microsoft trots back into the picture and snaps up Yahoo for $35 per share.

With the weighted average of those three options at $26 per share, Mahaney moved to downgrade the stock to "sell."

For its part, Microsoft saw its stock remain almost flat, dropping 0.55 percent to $29.08, while Google's stock rose 2.34 percent to $594.90.