Yahoo investor urges Microsoft search deal

Ivory Investment Management, which holds a 1.5 percent stake in the search company, says such a deal could result in a $24 to $29 per share value to shareholders.

Update at 7:29 p.m. PDT with closing stock price

Major Yahoo investor Ivory Investment Management on Wednesday called on Yahoo's board to restart talks with Microsoft and offered up a search buyout proposal that it claims could yield investors a value of $24 to $29 per share.

Ivory, which holds a 1.5 percent stake in Yahoo, is proposing Yahoo sell its search business to Microsoft for an upfront payment of approximately $15 billion, in which Microsoft then becomes the search provider for all of Yahoo's properties and its existing affiliates.

Microsoft would own and operate the combined search platform, making Yahoo an affiliate that would receive 80 percent of revenue generated from searches performed on its own site. Ivory believes that arrangement could also result in annual cash flow to Yahoo of nearly $500 million.

Yahoo jumped 9.93 percent to close at $13.40 a share Wednesday, rising higher than the broader markets with the Dow Jones Industrial Average gaining .81 percent and tech-heavy Nasdaq up 1.17 percent.

In its letter to Yahoo's board of directors, Curtis Macnguyen, Ivory's managing partner, said:

This deal would offer Microsoft the unique opportunity to immediately gain critical mass to better level the playing field with Google, while it would simultaneously allow Yahoo to both receive a sizable upfront cash payment and increase its prospective cash flow (i.e., EBITDA). There are two key reasons why we believe this proposed deal is extremely beneficial to both parties:

1) Approximately $800 million of duplicate operating costs could be eliminated. This estimate is based upon benchmarking Yahoo's and Microsoft's Online Services Business' operating costs versus Google's cost structure. At the Microsoft analyst day earlier this year, Steve Ballmer described the cost structure in their search business: "I think you've got to think of it as sort of almost more of a fixed expense...We won't have to be as high as Google's $2.3 billion because they're serving up so many more queries, but our COGS percentage will need to be quite a bit higher than theirs will, just to keep up in the ante to index the largest volume of documents on the Web."; and

2) The combined search platform and marketplace would have a much greater "network" effect, resulting in 20% higher monetization rates. Again we quote Mr. Ballmer at the Microsoft analyst day: "We'd like to increase our revenue per search, and the way to do that is to get more queries. The more queries we get, the more advertisers we get, the more keywords they bid on, the higher they bid, you get the virtuous cycle flowing." Furthermore, based on Yahoo's past comments regarding differences in monetization rates between Yahoo and Google, we believe our 20% monetization rate estimate is conservative. On a June 12th conference call this year announcing a search relationship with Google, Jerry Yang described the monetization differential between Yahoo and Google: "At the current monetization rate, we believe there is an approximate $800 million in annual revenue opportunity in the U.S. and Canada on those queries where monetization upside exists." This $800 million represents a 47% increase relative to the $1.7 billion of search revenue from Yahoo's total owned properties. However, this $800 million applies only to a subset of Yahoo's owned properties, so the total monetization differential between Yahoo and Google is actually greater than 47%. Thus, we believe our assumption of a 20% improvement is less than half of the potential opportunity and could grow substantially over time.

Ivory noted that Yahoo could stand to lose $2.15 billion in annual search revenue under its proposal, but said that Yahoo could gain $2.63 billion from affiliate payments from Microsoft and cost savings by eliminating duplicate search operations. The net effect would be $482 million in increased annual cash flow to Yahoo, Ivory estimated.

For Microsoft, Ivory estimated the software giant could increase its annual pre-tax profit by over $800 million.

Ivory said it's opposed to a Yahoo acquisition of AOL and that previous efforts to right itself have not panned out, while a number of key employees have left the company.

Macnguyen ended his letter with this plea:

One of your Board members, Mr. Icahn, has publicly stated that he supports a search deal between Microsoft and Yahoo. Considering the fact that (1) you arguably misplayed your hand by losing the initial $31 per share offer, (2) the stock is down over 60% from that price (vs. a broad market decrease of around 35%), and (3) Microsoft is still reaching out to do a search deal, we urge the remaining Board members to commence constructive discussions with Microsoft immediately. This time around, the Board cannot allow another tremendous value creation opportunity to slip by.

Ivory is not the first Yahoo shareholder to come up with a rescue plan for the struggling Internet search pioneer. Icahn himself, prior to joining Yahoo's board, submitted a joint proposal with Microsoft that called for Yahoo to sell its search business to the software giant.

Yahoo had rejected the Icahn-Microsoft proposal, in part noting its fortunes would be tied to how well Microsoft would be able to monetize the combined search business.

Microsoft and Yahoo representatives declined to comment on Ivory's proposal. And a spokesman for Ivory declined to comment beyond the company's statement and letter.

 

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