Icahn, Yahoo! fireworks far from over

Stock prices are delayed 15 minutes. Source: Globe and Mail.

He's an agitator par excellence, a true activist investor. When he witnessed what he believed to be Yahoo! Inc.'s mismanagement of Microsoft's takeover attempt, he said he'd take matters into his own hands.

In the middle of May, Carl Icahn launched a proxy fight.  His mission? To wipe Yahoo's board of directors clean, insert his own slate, and play Let's Make A Deal with Microsoft. 

The anticipation leading up to the online search company's annual shareholder meeting on August 1 becomes more frenzied with every passing day.  But after a surprise development this past week, it looks like the two sides are ready to play nice - for now.

A settlement was reached on July 21 when Yahoo said just eight of the current nine directors would stand for re-election.  Mr. Icahn dropped his dissident slate in return for a seat at the company's board.  Moreover, two new seats will be added, to be filled with Icahn-backed candidates. 

Mr. Icahn's hand was nudged - if not forced - last week when Legg Mason, one of Yahoo's largest shareholders with a 4.4 per cent stake, announced it would back the Yahoo board.

But Carmi Levy, senior vice president of strategic consulting with AR Communications, doesn’t see this as capitulation on Mr. Icahn's part.  In fact, he sees it more as a concession by Yahoo CEO Jerry Yang. 

"A continued battle with a recalcitrant major shareholder wasn’t in the company's best interest," Mr. Levy said via e-mail, "and Mr. Yang had to end the debate as early as possible before it did even more damage to the company’s future prospects."

And by the sounds of things, Mr. Icahn thinks Yahoo is sitting on all the right pieces, if only it could put the puzzle together. 

"While I continue to believe that the sale of the whole company or the sale of its search business in the right transaction must be given full consideration, I share the view that Yahoo!'s valuable collection of assets positions it well to continue expanding its online leadership and enhancing returns to shareholders," Mr. Icahn said.

But make no mistake about it, this is not a kinder, gentler Carl Icahn joining the Yahoo board, according to David Garrity, director of research at Dinosaur Securities. 

"It certainly is not a friendlier Carl.  He's not out to make friends.  He's out to make deals," he said.

This is the latest twist in a saga that dates back to last year, when Microsoft first started talking with Yahoo about a possible combination.  The company that revolutionized the software business needed more heft in the online world.  Not content to keep watching Google reign supreme in the search and online advertising markets, Steve Ballmer decided on February 1 that it was the time to act. He lobbed a $44.6-billion US offer Yahoo's way.  Investors would pocket $31 per share, a 62% premium to the $19.18 where Yahoo shares closed on January 31.   But, it wasn’t rich enough for Yahoo's brass.  They brushed aside the bid a little more than a month later.  Nevertheless, that didn't put an end to the courtship.  There would be behind-the-scenes talks between the two parties.  Microsoft's patience eventually ran out.  After an offer to raise its bid to $33 per share was met with a demand for at least $37 per share, Mr. Ballmer essentially ripped up the cheque in Mr. Yang's face.  On May 3, Microsoft officially yanked its offer off the table.

Perhaps it was fear over a showdown with the legendary agitator, but Yahoo's executive team tried to lure Microsoft back to the table in mid-May.  The Wall Street Journal reported one of Yahoo's directors and its chairman told Mr. Ballmer the company could be his for the $33 per share that was previously rebuffed.  Microsoft apparently said "no dice", at that point it was no longer looking to pursue a total takeover; it was focusing its attention on a search-only transaction.  Cue Mr. Icahn and his proxy fight.   

As time wore on, so, too, did Microsoft's patience.  Earlier this month, it threw up its arms and said there was no hope of making a deal happen with Yahoo's current board and management.  But the door was left open: it would be willing to give it another shot after the annual meeting if the board got the boot.  Less than a week later, another offer landed on Jerry Yang’s desk.  Microsoft and Mr. Icahn made a joint proposal that would have seen Steve Ballmer's company land Yahoo's search business, while the veteran investor would walk away with the rest.  Yahoo called the offer ludicrous, but repeated the entire company could be bought for $33 per share.

Is it possible the powers that be at Yahoo regret not taking that offer while they could?  Of course they do, according to Scott Kessler, Internet equity analyst at Standard & Poor’s in New York. But the issue is, they could never admit it publicly, lest they open themselves up to potential shareholder litigation. 

On Tuesday, Microsoft got a better look at the beast it has been hunting.  Yahoo's second-quarter profit dropped 18 per cent to $131-million, but the bar was low and the bottom line met expectations.  How much has the Microsoft and Icahn affair pinched Yahoo's coffers?  Apparently, it paid $22M in adviser fees in the quarter as it dealt with the distraction. 

Yahoo executives were saying all the right things after making its way through a rough quarter merely bruised, rather than broken. 

Take president Sue Decker, for example: "We remain confident that our efforts will lead to a stronger and more profitable Yahoo!," she said. 

Those are the kind of toe the company lines that Mr. Levy told BNN he sees right through. 

"…[I]t’s difficult to believe that any of them is so naïve to believe that Yahoo can absolutely pull itself out of its current predicament without some sort of major deal.  The company can only promise turnaround for so long before even its senior leaders lose faith and head for the exits," Mr. Levy said.

Nonetheless, Mr. Garrity reckons the results gave Yahoo's management team another six months worth of breathing room to show their mettle. As fate would have it, he pointed out, those six months also represent Yahoo's seasonally strongest time of year.  Once that time runs out, he thinks the company will still be independent, but Mr. Icahn will also return to his sabre-rattling ways. 

"He'll claim [Yahoo] is in such great shape," Mr. Garrity said, "but that it could be so much better.  So let's go back and re-engage with Microsoft."

But by that point, the ship may have sailed, according to Peter Misek, head of research & global technology strategist with Canaccord Adams.  He thinks the courtship took its toll on Microsoft. 

"I don't think Steve Ballmer feels like he has to do anything.  They're going to sit back and look at their options." 

Among the options, Mr. Misek thinks Microsoft is more interested in AOL as a takeover target than Yahoo at this point. 

"But [Microsoft] understands that not even buying AOL or Yahoo catches Google.  Nothing catches Google," he said.

Microsoft isn’t throwing in the towel in the search battle.  There’s too much at stake to not fight for a bigger piece of the pie.   Indeed, at its analyst meeting Thursday, Mr. Ballmer said at least $2.5-billion is being earmarked to bolster its search business.  But there’s no shortage of critics of Microsoft’s online strategy.  When its head of Internet operations walked away from the company this week, the skeptics saw this as another sign of lack of confidence in the company’s online strategy. 

As for growth by acquisition, Mr. Ballmer said there weren’t any ongoing talks with the folks at Yahoo, but he wouldn’t rule out returning to the table in the future. 

Time is of the essence, as far as Mr. Levy is concerned.  He says the longer Microsoft waits before it makes its move (regardless of whether that means buying Yahoo, buying a piece of Yahoo, or something else altogether), the more time it gives Google to extend its lead.

Meanwhile, Yahoo moves on after winning a cease fire in the public war of words with Mr. Icahn by bringing him into its inner circle.  The fireworks from the proxy battle have been extinguished.  But the drama is far from over.  Mr. Icahn may not have managed to give the board a total overhaul, but he’s in a position to influence the directors from within; that’s bound to keep the heat on Mr. Yang to deliver the goods.    

And if he doesn’t?

"A year from now," Mr. Kessler said, "I expect Yahoo to be in largely the same kind of form it is now.  But it wouldn’t surprise me in the least if they had some new management in place."

Yahoo holds its annual shareholder meeting Friday August 1st.

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