Microsoft buying Yahoo? The Yahoo shareholder’s dilemma

Last fall Cleantech Blog did an article on asking whether Microsoft Vista could be considered the best selling cleantech product in the world. And we have long admired the portal, so while maybe a stretch for Cleantech Blog, I couldn’t help but weigh in on the recent Microsoft (NASDAQ:MSFT) offer to acquire Yahoo (NASDAQ:YHOO).

One of my friends who formerly worked at Yahoo still holds some shares there. He knows I have liked Microsoft as a stock, and asked me to write him a quick note on the Microsoft bid for Yahoo. As a Yahoo shareholder, how does he decide whether to sell or hold? What’s the analysis?

The first part of the answer depends on some simple numbers around the tax basis and impact. If he sells now, he pays his 20% in taxes on the gain (depending on whether it’s long term or short term). If he holds and it does go through, it should go through at a roughly 10% higher price ($31 vs. $28), and he can possibly roll his tax basis (check this with your tax advisor, as the proposed deal is half cash and/or half stock – but I believe it is intended to be tax free at least for the stock portion). If he holds and it doesn’t go through, Yahoo could well give back the 50% it has traded up.

There is a reasonable likelihood of failure of the deal, as these discussions between Microsoft and Yahoo are not new. But perhaps the risk of failure is no worse than 50/50. The market has basically said it believes there is a greater than 70% likelihood on the deal going through, or Microsoft getting beat out by someone else, i.e., a $31 offer price, $19-20/share previous price, and a Yahoo price that traded up immediately to $28 today. I can’t see anyone else easily outbidding Microsoft at this scale (though Microsoft may well have to sweeten the deal), as Google would have antitrust issues, and while that’s always a possibility, too, probably not too likely.

So we are left with perhaps a 10-20% upside versus a 50%+ downside, and our market estimate of a 70%-75% likelihood of the upside. This analysis would argue possibly for a sell rather than a hold, but not by much.

But I still think from a product perspective a Microsoft / Yahoo combination could be a formidable challenge to Google and deliver long term growth to Microsoft – in which case holding gets him Microsoft stock at up to a 20% discount from where it is today – 10% from Yahoo’s current trading price discount to the $31 offer, and depending on the tax analysis and your basis likely another 10%+ on the tax deferral. Think about it – a Yahoo portal, instant messenger, search, advertising, groups, and all bundled directly to my desktop – and tied long term into my corporate back office. Very intriguing.

I am personally into Microsoft at around $24/share, and like it as a buy probably up to $35 or so. I have never owned Yahoo. But if I were a Yahoo shareholder, I think I’d like this deal. Yahoo’s PE has been trading in the 30s, and is currently at 50+ on the back of this announcement, while Microsoft’s has been in the mid-teens. So, if you are Yahoo shareholder and hold through a deal, you also get a much cheaper stock in the bargain.

No real answers here, just the analysis.

Neal Dikeman is a founding partner at Jane Capital Partners LLC, a boutique merchant bank advising strategic investors and startups in cleantech. He is founding contributor of Cleantech Blog and a Contributing Editor to Alt Energy Stocks, and a blogger for CNET’s Green tech blog.