Steve Ballmer and the Microsoftdom of Yahoo

News Analysis. Grab the popcorn. Like the fourth Indiana Jones movie, the Microhoo drama has another sequel.

This afternoon, Microsoft issued a statement indicating that a new—and perhaps even different—Yahoo deal is in the works. The statement comes three days after billionaire business buster Carl Icahn launched a proxy fight to oust Yahoo's board of directors.

As I said on Friday, Carl's coup could cripple Yahoo, creating market share and customer grabbing opportunities for Google. Microsoft can't let the proxy fight destroy Yahoo to the benefit of Google.

I'm not surprised that Microsoft is once again talking some kind of deal. A hostile Yahoo takeover would cause Microsoft loads of self-harm, perhaps more than any good. Even a friendly takeover would have questionable benefits because of the enormous product and service overlap between the companies. But if the choice is some Yahoo deal—even a new acquisition—or strangulation at the hands of Carl Icahn, I say make the deal. Any deal.

Microsoft stands to lose more to Google, in a protracted proxy fight that also damages investor and, more importantly, customer confidence in Yahoo. Google is much more likely to pilfer fleeing customers than is Microsoft. Again, as I said on Thursday, Microsoft might be the white knight that can save Yahoo from Carl Icahn.

Even before Carl's proxy fight, I expected that Microsoft would come back if invited by Yahoo. It was clear to me that Microsoft CEO Steve Ballmer's letter withdrawing the bid was aimed at shareholders and even stirring up some revolt among them. But the revolt didn't come from within, but outside in the form of a billionaire investor who has a history of waging proxy battles against seemingly beleaguered companies.

On May 5, eWEEK.com ran a Reuters story quoting Craig Mundie, Microsoft chief strategy and research officer: "The market may wish that the Yahoo deal may come back together, but Microsoft at least at this point assumes it's over." We had some internal debate about what the statement meant. Earlier, an editor had interpreted the statement in a headline to mean Microsoft had closed the door on any deal. I read the statement quite differently.

In an IM conversation with another editor, I asserted: "That's an editorial interpretation. He's not quoted as saying that. He says that Microsoft assumes it's over, which is hugely different. Yahoo could easily come back and accept a lower bid—and there's a deal. These Microsoft people are always deliberate in their wording."

Craig's "at this point assumes" was a huge open door to a future deal. Now, a new deal is in play. Today's Microsoft statement:

"In light of developments since the withdrawal of the Microsoft proposal to acquire Yahoo! Inc., Microsoft announced that it is continuing to explore and pursue its alternatives to improve and expand its online services and advertising business. Microsoft is considering and has raised with Yahoo! an alternative that would involve a transaction with Yahoo! but not an acquisition of all of Yahoo!"

Is what's good for Yahoo good for Microsoft? Companies don't usually disclose transactions while they are being negotiated. The public statement applies pressure on Yahoo's board, which already has got more than it can handle in Carl's proxy fight.

Remainder of the Microsoft statement:

"Microsoft is not proposing to make a new bid to acquire all of Yahoo! at this time, but reserves the right to reconsider that alternative depending on future developments and discussions that may take place with Yahoo! or discussions with shareholders of Yahoo! or Microsoft or with other third parties. There of course can be no assurance that any transaction will result from these discussions."

Yahoo responded to Carl Icahn on Thursday, but, as of this posting, not yet to Microsoft's statement. By itself, the statement is hugely beneficial to Yahoo's board and could instill confidence even as Carl seeks to undermine it (there is the aforementioned benefit of applying "pressure," too). Perception is everything in business. Carl's proxy fight can only succeed by creating negative perceptions about Yahoo's board. Microsoft's four-sentence statement should boost Yahoo perception and likely the share price come the stock market's opening on Monday.

The statement also creates uncertainty because Microsoft might not buy Yahoo after all. No new bid is yet on the table, just discussions that could lead to business transactions or even acquisition of some Yahoo assets. That said, the statement is clear that Microsoft could "reconsider" an acquisition.

If not for Carl Icahn, I would still advocate that Microsoft walk away. Now Microsoft must rally to Yahoo for its own benefit, lest Google gobbles a bunch of Yahoo customers and market share in a short time. Microsoft's motivations may have absolutely nothing to do with the billionaire business buster. But they should.

Regardless, his attack has put Yahoo's board in a weakened position and one where board members should want some kind of deal with Microsoft. If the choice is between the devil Yahoo knows (Steve Ballmer) and the one it doesn't (Carl Icahn), take Microsoft. At least Microsoft wants to make something better out of Yahoo.

Icahn Yahoo Better than You?

News Commentary. Maybe Yahoo should have taken Microsoft's money. Suddenly, there are worse assaults.

Carl Icahn's proxy fight is sure to put an end to Yahoo as we know it—unless a majority of investors rally for the company's cause. But proxy fights favor large investors like Carl is trying to be, even though they are the minority holders in Yahoo.

The proxy battle also illustrates one of the many things wrong with the rules, whether enforced culturally or with regulations, that govern public companies. Yahoo CEO Jerry Yang clearly is in process of turning around the company he co-founded. His predecessor spread Yahoo too far and too thin in an effort to make it into a global media conglomerate. Jerry is aligning Yahoo's priorities with the competitive Web 2.0 marketplace.

Jerry needs more time to right the listing, but by no means sinking, ship. Yahoo may be between a Google rock and a Microsoft hard place, but there is hope in good leadership. (Apologies for the mixed metaphors.) Jerry's team is making Yahoo more pliable, and maybe just pliable enough to squeeze between the rock and hard place.

Shareholder Moral Dilemma
Microsoft's unsolicited bid and now the proxy fight distract from the task at hand. We may never know if Jerry's team could fix Yahoo, because of Carl's self-centered action. I say that not as a value judgment but as a pragmatic observation. He's a ruthless investor and well-known shareholder activist. But is Carl a longstanding investor in Yahoo? He bought 59 million shares or share equivalents following Microsoft's bid withdrawal and seeks to acquire as much as $2.5 billion in Yahoo stock. Carl is suddenly a major Yahoo investor, but is the objective his benefit or Yahoo's? Need I answer?

There is no moral high ground in business. The high ground is quagmire, because all public companies share one, and only one, moral objective: Make profits for stockholders. It's the great contradiction about public companies and the people who own them. U.S. law treats businesses like people, but the organizations don't share the same moral objectives as human beings. The "good of all" isn't about humankind but shareholders. This moral difference is one of the major reasons some businesses egregiously act against the common good of all people. But that's a moral topic for another venue.

The moral issue here is a simply stated question: Who is acting in the best interest of all Yahoo shareholders, Carl Icahn or the company's CEO and board of directors? The answer is the measure by which Carl and Yahoo's board should be judged. My secondary question: What makes newcomer Carl a better judge of what Yahoo should do than people who have been committed to and invested in the company for a long time? (For the record, I am not a Yahoo investor or an investor in any other company.)

In his letter to Yahoo Chairman Roy Bostock, Carl asserted:

"The board of directors of Yahoo has acted irrationally and lost the faith of shareholders and Microsoft. It is quite obvious that Microsoft's bid of $33 per share is a superior alternative to Yahoo's prospects on a standalone basis. I am perplexed by the board's actions. It is irresponsible to hide behind management's more than overly optimistic financial forecasts. It is unconscionable that you have not allowed your shareholders to choose to accept an offer that represented a 72 percent premium over Yahoo's closing price of $19.18 on the day before the initial Microsoft offer. I and many of your shareholders strongly believe that a combination between Yahoo and Microsoft would form a dynamic company and more importantly would be a force strong enough to compete with Google on the Internet."

What Happened Before?
Perhaps the measure of Carl's competence to judge Yahoo's board is the past—what happened to other companies besieged by his attacks? Carl's proxy battle to get on Motorola's board failed, but his vicious public criticisms helped undermine confidence in the company. In business, perception is everything. His unsuccessful proxy fight fostered the perception of a weak Motorola—I'd say weaker than it really was—and led to the eventual departure of CEO Ed Zander. How exactly did a perceptually weakened Motorola benefit investors?

Carl's investment in and battle with BEA Systems also undermined confidence in the company and led to its acquisition by Oracle. Are BEA shareholders better off because of Carl's actions? Rather than do the math, I'll ask: If you were a BEA investor, tell me and Microsoft Watch readers in the comments what you think. Did you benefit or lose out?

If you take a hard look at Carl's attack strategy, he invests in companies that appear to be weak and through investment and proxy fights increases the perceived weakness. BEA, Blockbuster, Motorola and Yahoo were all struggling companies with solid foundations when Carl moved in on them. Did all shareholders benefit?

I'll take a single example as answer: Blockbuster stock traded for around $10 a share in May 2005, when Carl's proxy fight won him and two associates seats on the board of directors. In a CNBC interview, Carl described the proxy fight as "a very strong victory. Most importantly, we want accountability." But who's accountable to other shareholders? When I wrote this paragraph, Blockbuster shares were $3.18.

Winner Lose All?
Carl stands to profit from a proxy fight, but he also risks losing hundreds of millions—maybe billions—along the way. His proxy fight is based on the assumption that Microsoft would still acquire Yahoo. That's a rather bold assumption, frankly. Microsoft might come back with an offer, but likely much less than $33 a share—and the premium wouldn't be as great. Carl could still profit nicely from buying shares cheap and cashing in at higher value. But how is that in the best interests of all, or even most, Yahoo shareholders?

Carl's proxy battle can only hurt Yahoo—and Microsoft should weigh the competitive impact of any damage. The proxy battle and, if successful, new board of directors would create grave uncertainties about Yahoo's future. Customers don't like uncertainties, particularly with the economy rocking unsteadily. They need their ads served up by a company they can trust. Google would likely be the greatest beneficiary, picking up advertising and search customers from Yahoo. That's an outcome Microsoft doesn't want.

Microsoft CEO Steve Ballmer knows this. Why do you think he walked away? A proxy fight would diminish Yahoo's value and undermine confidence in day-to-day business operations. Negative perceptions about Yahoo would drive customers away and into the open embrace of Google. I expect that Microsoft would pick up some customers, but Google would take many, many more. A weakened Yahoo could help Microsoft later on, but not yet and certainly not from the kind of perceptions a proxy fight would create.

Strangely, Microsoft might be the white knight that can save Yahoo from Carl Icahn. If Steve and Jerry aren't already talking about a new deal, they should be. Carl just set off the timer on a very dangerous proxy bomb.

Whether or not Yahoo's board wins the proxy fight is immaterial. If Carl uses his past playbook—and his letter indicates that he will—the proxy fight will undermine confidence in Jerry, the board of directors and Yahoo management. It's a lose-lose situation for them and Yahoo. If Carl successfully ousts the board, he may win the battle but lose the war for all Yahoo shareholders, particularly if Microsoft doesn't deal. Then the weakened Yahoo would be crushed between the Google rock and Microsoft hard place.

What do you think?