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Tickers in this Article: MSFT, YHOO, GOOG, TWX
Yahoo (Nasdaq:YHOO) formally announced Monday morning that it is rejecting the $31 per share unsolicited offer that Microsoft (Nasdaq:MSFT) had put in just a little over a week ago. Yahoo's directors declared that the bid "substantially undervalues" the company. But, with the offer representing a 62% premium to where the stock was trading before the announcement, are they really serious?

This seems a bit like the - ahem - classic movie "Can't Buy Me Love" where the class geek (Yahoo) bribes the most popular and beautiful girl in school (Microsoft) to date him and make him popular. It works; he becomes popular, and in the process the girl eventually comes to recognize his "inner beauty" and falls in love.

She professes her true love and suggests a "merger", but the nerd, puffed up with a newfound sense of popularity and self importance, rejects her. He abandons her so he can hang out with the cool kids (the investing community). But of course, the cool kids quickly see through the facade and our hero is made an outcast once again. He's left broken and alone. Yahoo's executives might want to take a look at this movie. The company is popular right now, but only because Microsoft brought it to all the cool, rich kid parties.

Play Chess, But Tone It Down
On January 31, Microsoft shocked the market with an unsolicited cash and stock bid to take over Yahoo, in a deal that valued the company at more than $44 billion, but has decreased slightly due to share movements to around $41.6 billion. Yahoo fought back when it rejected the offer. It is not entirely surprising that this happened, since Yahoo directors are trying to squeeze another buck or two out of the Microsoft camp. Many expect that Microsoft will raise the offer a little to ensure goodwill from Yahoo's board, and Yahoo's shares rose 67 cents or 2.3% with the rebuff, but Yahoo should tread carefully.

First of all, the claim from Yahoo that this substantially undervalues the company is a bit absurd. If $31 per share substantially undervalues the company, then why was the market valuing the internet search company below $19 per share before this bid? Yahoo was reporting poor quarters, a 20% drop in net income for the fourth quarter, and the stock was on a steady slide. This high premium bid was a lifeline. Shareholders realize this and one group has already dissented by reporting that they will sell their shares to the highest bidder. (To learn more about corporate love affairs, see The Wacky World Of M&As and Cashing In On Corporate Restructuring.)

Stop Complaining About The Quality of Your Life Preserver
Microsoft rightfully blasted back saying that its bid was "full and fair", which it is. The market clearly thinks Microsoft will budge a little, but it really does not have to. Apparently Yahoo is looking for at least $40 per share, and that seems ridiculous. It would be cheaper for Microsoft to battle it out and do a hostile takeover than to pay that much. With the current price, the deal is financed quite attractively for Microsoft, and would remain so even if a few more dollars per share were added to the bid. But, there are no other bidders.

Microsoft does not have any incentive at this point to move higher, except to smooth out the deal. There has been talk about Yahoo forming alliances with Google (Nasdaq:GOOG) or trying a combination with AOL a troubled unit of Time Warner (NYSE:TWX). But with Google representing nearly 60% of the U.S. search market, antitrust issues would not let such deals happen easily, and some combination of AOL and Yahoo would probably not do anyone any good. (For more on monopolies, see Antitrust Defined.)

I think you may see Microsoft bide its time, then up its bid one or two dollars per share. Yahoo's management and board would be foolish to expect any more. I would not be buying the shares, hoping for this type of a bid, it just does not seem realistic. A price of $40 would make the deal unattractive to Microsoft, as Yahoo has been slumping and last quarter reported lower numbers and decreased guidance. The company should be happy that it is being rescued.

The Bottom Line
Yahoo's board rejected Microsoft's big offer to buy the company. Shares rose on the news, as it is widely expected that Microsoft will raise its bid a little. None of this is surprising, but the language Yahoo used that the bid substantially undervalues the company was. Microsoft's bid was a 62% premium to the slumping stock price, and while the bid may move up, Yahoo should be careful. The deal is very good, and Yahoo does not have much to bargain with.

Let's jump back to our movie analogy again. "Can't Buy Me Love" was made in Hollywood so, of course, our geeky hero does eventually get the girl after he learns the error of his ways. Unfortunately for Yahoo, business doesn't have a guaranteed happy ending, and it might be best to just grab a good thing before it's gone.

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