Yahoo! - Everybody's Favorite Target?

By Stephen D. Simpson, CFA | October 06, 2011 AAA

As a general rule, investors should never pay much attention to buyout rumors that spring up in the weeks immediately preceding another earnings cycle. Buy-side analysts and managers are desperate for any shred of tradeable information, sell-side analysts are desperate to drive trading, and financial writers are desperate to meet quotas and deadlines.

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When times are tough, desperate people go back to what's comfortable. In tech, that means rumors and speculation around the fate of Yahoo! (Nasdaq:YHOO). This time around, though, the change in leadership at the company at least makes the speculation seems a little more fresh.

The Obligatory Microsoft Mention
Although Microsoft (Nasdaq:MSFT) never seems to move when or where the experts say it will, analysts and writers continue to flog the "Microsoft should buy Yahoo!" meme. Okay, it makes some sense. Microsoft and Yahoo! are interlinked in the internet search business and it is not hard to imagine that properties like Yahoo! Finance and Yahoo! Sports could be leverageable on the MSN platform.

But c'mon already. The companies have done this dance before, Yahoo! said "no", and Microsoft has moved on with other plans. It is a little hard to see why Microsoft would spend real money to buy Yahoo! when deals like Skype and efforts to keep up with Google (Nasdaq:GOOG) and Apple (Nasdaq:AAPL) in mobile computing/telephony are taking a substantial part of management's attention already.

Could Prey Become Predator?
All of the speculation about Yahoo! selling out also belies the possibility that the company could be a buyer and not a seller. While an acquisition of AOL (NYSE:AOL) would not make all that much sense (though it seems a popular rumor), a deal for Hulu could make some sense. Moreover, Yahoo! is a company that seems so unsure of its identity or future that a bid for a company like Monster Worldwide (NYSE:MWW) is not unthinkable (even given all of the back-and-forth Yahoo! has had with job search properties).

The trouble for Yahoo! is that the company has had good ideas in the past but has never been able to fully execute on them. Yahoo! predated Google in search, the company's free email service followed shortly after Hotmail, and the company was in online music long before Spotify. But who cares about any of that now? Instead, Yahoo! has found itself circling the same dustbin of early Internet history as AOL and Netscape, and investors may see another acquisition as a waste of capital.

Alibaba to the Rescue?
Alibaba, a Chinese internet conglomerate, is reportedly also interested in considering a bid for Yahoo!, with a little added irony from the fact that Yahoo! holds a significant financial interest in Alibaba. This deal makes a certain amount of sense - not only does it consolidate the ownership of Alibaba, but it ends some of the squabbling that has gone on between the two companies.

In fact, simply consolidating more control over Alibaba could be sufficient motivation - any sort of improvement in Yahoo!'s operations or monetization of Yahoo! Japan would just be gravy for Alibaba. By the same token, there will be people howling about a Chinese company buying an American company, particularly one that has <gasp!> personal information about Americans in its hands, so approval of the deal is hardly certain.

The Bottom Line
Yahoo! is a $20 billion company with well over $5 billion in revenue and $2 billion in cash and yet analysts and commentators talk about it as though it is irrelevant. Such is the power of years of bad management and inadequate leadership. That also holds an important message for shareholders, though - although the company's cash flow trajectory is very worrisome (as is its lack of identity or leadership), it is still a ways away from having to submit to being any company's pity purchase.

While Alibaba makes sense as a buyer, there could be some off-the-wall bid from a party like InterActiveCorp (Nasdaq:IACI) or Liberty Interactive (Nasdaq:LINTA). Oh sure, both companies are much smaller than Yahoo! but would such a deal really be the strangest or most aggressive move made by John Malone or Barry Diller in their respective careers? At the very least, it seems safe to close on the thought that the financial circumstances of the company may mean that the board will stubbornly stick to another new plan for growth rather take a low-ball bid from anybody. (For additional reading, check out Pinpoint Takeovers First.)

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