Who is the Best Suitor for Yahoo?

After two months of foot-dragging and stumbling by both Yahoo and Microsoft doing nothing for shareholder value, the action has heated up.

Yahoo (NASD:YHOO) took an early shot yesterday, announcing a test under which they would route 3% of their search traffic through Google (NASD:GOOG). This is a potential precursor to outsourcing search to Google, a move that analysts called for more than six months ago.  Such a move could provide an EBITDA boost of between $300-500 million per year, according to Silicon Alley Insider.  As SAI points out, while such a deal might not scuttle the Microsoft bid, it could help justify a bump of $5 per share in the price.

The bigger blow came last night, as it emerged that discussions with Time Warner (NYSE:TWX) had heated up and that Yahoo was close to finalizing terms for a potential merger with AOL. Under this deal, Time Warner would merge AOL into Yahoo, along with a cash infusion, in return for 20% of the combined company. The cash would be used to buy back Yahoo shares in the public markets at a price somewhat higher than the $31 Microsoft offer.

Meanwhile, Microsoft (NASD:MSFT) is apparently poised to launch a counter-offer in combination with News Corp  News Corp (NYSE:NWS) has been trying to figure out a way to get into the Yahoo sweepstakes but hadn’t been able to find financial backers for the deal.  According to reports, the deal would combine Yahoo, MySpace and MSN into a massive consumer internet business.

So, which of these potential deals seems more attractive? In part, that depends from whose vantage point you look at it.  Let’s take a closer look:

YahooAOL:
For Time Warner, the deal is a no-brainer. They’ve been trying to figure out how to get value out of AOL for quite a while and the combination of the two would create some immediate benefits:
•    Dominant positioning for online display advertising and ad networks
•    Increased leverage with Google (assuming the combined entity would outsource its search to Google)
•    Combination of strong destination sites in finance, travel, entertainment and other markets
•    There would be obvious cost-cutting opportunities due to the large amounts of overlap between the companies.

For Yahoo, the deal is attractive for some of the same reasons, but does the combination of two declining properties really create a competitive player? Yahoo is pushing this deal as they want to remain an independent company but that desire alone does not create the most long-term shareholder value.

MyYahooMSNSpace:
From a Yahoo or News Corp perspective, this could actually be the more compelling of the two deals.  Combining Fox Interactive with Yahoo could provide significant growth opportunities. The combination of Yahoo’s display advertising expertise plus the social networking growth of MySpace would be extremely attractive.

The benefits to Microsoft are questionable, as has been pointed out in the past.  Microsoft is sitting on a good amount of cash today. The question is whether they’re best served investing that into a consumer Internet play or focusing on the b2b software markets. While the Internet side has more sizzle, the software side of the business could be a better long-term investment. Analysts have suggested that for the same price, Microsoft could acquire businesses like Salesforce.com, Omniture and Facebook.

Comments

[paul martin]

personally i think buying companies on the rise makes a lot more sense as Facebook, Omniture and Salesforce.com are all on the rise and i do not see them loosing steam soon. Money is valuable no matter how much you have, so buying the declining yahoo will benefit yahoo more than it will benefit Microsoft. such a deal seems parasitic to me.