Commentary

Yahoo Contemplates Future Options

It is not over by a long shot, but the surprising weekend turn of events in the continuing Yahoo saga raises the question of how founding CEO Jerry Yang has managed to skirt disaster and still keep his company and his job.

To be sure, neither Yahoo or Yang's position in it will stay the same.

As a result of the two leading Yahoo shareholders--Legg Mason and Carl Icahn--agreeing to work with a reconfigured Yahoo board, the direction and fate of the company may be resolved more expeditiously. Until more definitive moves occur, it's all about expectations.

Icahn buckled by ending his proxy fight in exchange for three Yahoo board seats; it is his only hope of making a decent return on his 5% investment in the company. Yahoo shareholders overall remain wanting. It was game over for the Aug. 1 proxy fight Icahn wagered when Bill Miller of Legg Mason, a 4.4% investor, declared on Friday that it will side with Yang and his current board. So what now? Icahn and his two Yahoo board appointees press for some kind of deal with Microsoft--most likely acquiring or joint venturing with Yahoo's search business.

The nomination of former AOL CEO Jonathan Miller (recommended by both Icahn and Yang) could signal an imminent deal with Time Warner's AOL. It could be an outright merger and acquisition, or a strategic joint venture. Either way, Yahoo wins as Miller not only brings his affable insights to the board, but a lifeline to startups through his co-founded Velocity Interactive Group. Among candidates for the third-Icahn-appointed board seat are well-regarded Internet entrepreneur Mark Cuban and former Viacom CEO Frank Biondi.

Given the name-calling, whistle-blowing and general bad blood between Yang and Icahn, they may not agree on enough to facilitate meaningful change from within. It's unknown how Gordon Crawford of Capital Research, which has a 6.5% Yahoo investment, will come down. Some clarity may come during Yahoo's second-quarter earnings call today.

While change at Yahoo is imminent, the quality of change is what matters. It's unclear whether any of the players or options can take Yahoo to the next level and make up for opportunities it already has missed in social networking, online video, search advertising and cloud computing. How much deeper should Yahoo delve into content and communications?

Transformational change can come only in a major merger with Microsoft or possibly AOL, although the latter is a stark reminder that simply uniting companies does not assure success. The unrealistically high bar that Yang has set for future Yahoo revenues and earnings, particularly in a weak economy, cannot be met by an independent Yahoo.

Here's what has to happen.

Some kind of Yahoo-Microsoft deal will occur just because both companies are strategically needy. Microsoft has no Internet strategy; its online business did miserably last quarter. An outright merger of the two companies is still not out of the question--stranger things have happened. Yang has publicly said he would sell to Microsoft for $33 a share.

For its part, Microsoft is a software application giant with $30 billion of cash that must compete with Google and Apple (dominating PC growth without Windows) by becoming meaningful in online advertising and placing a bet on cloud computing. In less than a year, Google's search business will exceed the size of Microsoft's monopolistic Windows business. Although Microsoft has said it would negotiate with an Icahn-led board, it could use the latest change as a reason not to hold further discussions. On the other hand, Icahn's representation on Yahoo's board could help things along.

Alternatively, either Yahoo or Microsoft could do a deal with AOL, which Time Warner is seeking to flip for between $8 billion and $12 billion. It would provide community, content, communications and more of a search advertising base.

Yahoo must either monetize or spin off its investment stakes in Alibaba, Yahoo Japan and others among its Asian Internet interests, representing about half its market value. It could use a cash infusion or a global partner to capitalize on emerging market growth. Yang recently said he would be willing to spin off Yahoo's international interests. Icahn is joined by other investors and analysts in believing that Yahoo must sell outright to Microsoft or spin off its assets in light of its deteriorating search and overall operating performance.

Yahoo needs new executive leadership; Jonathan Miller could step in as CEO, given the right assurances and compensation. The company's employees have become schizophrenic in their support of Yang; those who have not exited are paralyzed by uncertainty. As with shareholders, there is rampant loss of confidence in management.

Yahoo's proposed outsourcing deal with Google for search advertising will generate $1 billion of new annual revenue and increase Yahoo's search rates about 23%, while giving Google 90% control of Internet search advertising. That pending pact could be in jeopardy of crossing antitrust lines if Yahoo aligns with AOL or Microsoft.

Declarations by Icahn and Legg Mason have shifted the fighting to other fronts as the Aug. 1 shareholders' meeting approaches. Although an aggressive and growing independent Yahoo would have been better for competition, it is too late now. The Internet landscape will radically change over the next several years, as will the growth strategies and ownership of Yahoo, Microsoft and AOL. In the interest of lost value, these companies should more expeditiously seek to determine their own destinies before they are shaped for them.

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