Yesterday, we proposed a way for Microsoft (MSFT) and Yahoo (YHOO) to combine forces against Google that would turbo-charge Microsoft’s online effort without being a disaster for Yahoo: Microsoft selling its online division to Yahoo in exchange for equity, board seats, strategic relationship, etc.
Saul Hansell at the New York Times liked this idea, but noted two key obstacles:
- Microsoft’s online division is no longer a discrete entity (Instead, Microsoft is now trying to build Google “cloud computing” functionality into every product it sells).
- Microsoft’s online business is worth so little that, to Microsoft, the current value of the trade would barely qualify as couch change (ah, but the future value…).
These two issues are in part why we assigned such a deal a 0.0004% probability. The other reason is Microsoft’s colossal ego: Steve Ballmer, we think, would rather go down with the online ship than admit defeat.
Saul also challenged us to estimate how much equity Microsoft should get in the combined company (in other words, what Microsoft’s money losing online services business is worth). Here’s our answer…
- Microsoft Online division incinerating cash (nearly $1 billion a year)
- Approx 20% of Microsoft Online revenue is dial-up subscription, which is going to zero.
- Yahoo profitable but in need of cost cuts, margin improvements
- Microsoft could bring lots of strategic value (but might not)
- Combined company would need to cut at least $2 billion in costs, mostly from Microsoft
In sum: Despite Microsoft’s cash bleed, one might argue that each dollar of Microsoft ad revenue is worth about the same as each dollar of Yahoo revenue (assuming lots of Microsoft cost cuts, etc.). You can fight about value of Microsoft’s dying subscription business, value of Yahoo’s non-operating assets, relative profitability of Microsoft recent acquisitions vs. Yahoo Publisher Network, value of Microsoft relationship, etc., but all that is probably a wash. So…
MICROSOFT ONLINE BUSINESS
Q3 Microsoft Online Revenue Annualized: $2.7 billion
Q3 MSFT Online Subscription Revenue Annualized: $700 million (This is worth only a bit more than zero).
Annualized Microsoft Advertising Revenue Run-Rate: $2 billion
BACK OF ENVELOPE VALUATION
Yahoo Annualized Revenue Run-Rate: $7 billion
Yahoo Current Market Cap: $35 billion
Yahoo Current Revenue Multiple: 5X*
Microsoft Online Value at 5X Revenue Multiple: $10 billion
Market Cap of Combined Company: $45 billion
Combined Company Revenue Run-Rate: $9 billion
Microsoft Ownership %: 22%
Yahoo Ownership %: 78%
PS: Don’t come whining to us about how Microsoft Online can’t possibly only be worth $10 billion because they just paid $6 billion for aQuantive. Microsoft’s testosterone-fuelled tactical M&A decisions aren’t the point here.
*In the first version of this post, I divided 35 by 7 and got 6. Lord help me…