Handicapping the YHOO-MSFT Scenarios

Citi’s Mark Mahaney handicaps five scenarios for Yahoo’s future. His thoughts (and ours) below:

1.  YHOO Hits the $31 Bid, 20% probability.  Logic: attractiveness of a 62% premium, likely lack of alternative bidders, YHOO’s limited strategic options.

We (SAI) would put this probability at 40%.

2. YHOO Rejects, MSFT Bids Higher, Sale Happens, 40% probability. – Deal makes significant strategic sense for MSFT. Based on analysis of valuation assuming $1B in synergies (MSFT’s goal), our sense of the strategic value of Yahoo! to Google vis-a-vis Google, and our review of bid histories in the software space makes us think this is the most likely outcome – 40% chance.

We agree: 40% probability. For us, that’s an 80% probability that Yahoo sells to Microsoft at $31 or better.

3. Another Bidder Emerges & Wins, 5% probability. – We believe that the $45B price tag and the strategic value of Yahoo! to Microsoft make the likelihood of a successful competing bidder very low. 5% probability.

We put this at a 1% probability.  It’s not impossible, but when competing with that market cap and cash flow, it’s close.

4. Deal Blocked By Regulators, 10% probability. – We estimate that Microsoft and Yahoo! today account for at most 30% of total U.S. online advertising, with their combined market share less in Europe. Thus, while we would expect substantial regulatory review, we assign this outcome only a 10% probability.

We put this at 5% probability. If regulators block this deal, the regulators should be fired.  How can one make an anti-trust (or other consumer protection argument) when the leader in the space will still be the leader in the space and has $17 billion in revenue? We understand why, for the purposes of this particular endeavour, Google is trying to frame “the Internet” as a PC application, but this, of course, is laughable.

5.  Yahoo! Outsources Search to Google. Citi believes the probability of search-outsourcing (25%) is greater than financial markets realise. If Yahoo!’s Board and Management want to remain independent, shareholders will insist on a major, value-creating strategy to balance the MSFT bid. This may be the only viable strategy, as it could deliver 25%+ accretion to YHOO’s cash flow.

Whether or not search is outsourced, however, we still think Microsoft will press the deal through. The odds that Yahoo will outsource, therefore, may well be 25%, but the odds that this will deter shareholders from taking Microsoft’s money are slim–14% in our opinion.

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