Yahoo/Microsoft - Will It Succeed?

Yahoo-Microsoft May Lose Market Share

Yahoo (YHOO: Nasdaq) By Cantor Fitzgerald ($19.18, Feb. 1, 2008)
On Feb. 1, before the open, Microsoft extended an unsolicited offer to buy Yahoo! for $44.6 billion, or $31 per share, in equal parts cash and stock.
Yahoo's board of directors is in the process of evaluating Microsoft's proposal, which values Yahoo's enterprise at about six times our 2008 net revenue estimate, 19 times our adjusted earnings before interest, taxes, depreciation and amortization estimate, and 45 times our pro forma earnings per share estimate.
Paraphrasing Microsoft, this transaction seems to be about cost-saving synergies, scale, and consolidation, all in an effort to create a more credible, compelling, and competitive alternative to Google.

We expect a deal to happen, perhaps at a slight premium to the current offer, given Yahoo's weakened market position and Microsoft's obvious need to become more relevant in the consumer Internet services / online advertising arenas.
Nonetheless, we hold little hope that a merged Microsoft/Yahoo entity would radically alter the current competitive landscape; in fact, we think the combined company could actually lose market share to Google and others over time, as product, infrastructure, and cultural integration challenges divert attention/resources from the critical areas of innovation and customer service, and as red tape/size/bureaucracy further increase time-to-market for new products/services.

Reflecting these events, and the shares' early reaction, we are maintaining our
Hold rating on Yahoo's stock, but raising our price target to $31 (from $21). Our price implies a 2008 enterprise value-to-net-revenue multiple of about six times, an enterprise value-to-adjusted-EBITDA multiple of about 19 times, and a price-to-pro forma EPS multiple of 45 times. While these multiples seem high, given Yahoo's competitive struggles and projected three-year revenue growth rate of about 10%-20%, as well as shifting industry dynamics, and comparable company valuations, they are in line with Microsoft's current buyout proposal.

We see a number of potential risks to our rating and to Yahoo's business. These include, among others: the company's ability to attract new clients and maintain current client relationships; fierce competition in the Internet advertising, technology, and services marketplaces; spending decisions and budget allocations by clients or prospective clients; pricing pressure in some lines of business or changes in the availability and pricing of advertising space; and the ability to identify, attract, retain and motivate qualified personnel at a reasonable cost.
Additionally, acquisitions or investments may be unsuccessful and may divert management's attention. Other hurdles include: unmanageable or excessive levels of click fraud; changes in consumer behavior; the company's ability to maintain and/or add to its roster of Network distribution partners; geopolitical and macroeconomic uncertainties that may also negatively impact Yahoo's business; growth management tied to new categories and geographies, value-added services, and client relationships; and, new privacy legislation, industry standards, or other regulations.