Yahoo investors could get final say on a search sale

Yahoo investors who feel their hands are tied while sitting on the sidelines of a potential Microsoft-Yahoo search transaction may find a crack in the door to weigh in on the deal, legal experts say.

That crack, albeit small, could give Yahoo shareholders the right to vote on whether the Internet search pioneer would be able to sell its search business, say legal experts.

Under Section 271 of the Delaware General Corporation Law, companies are required to seek shareholder approval for any sale of "all or substantially all" of the corporation assets.

The "substantially all" is a squishy phrase that Yahoo and Microsoft attorneys will have to tread through carefully, should they wish to avoid shareholder revolt if they pursue a deal that calls for the sale of Yahoo's search business to the Redmond giant.

Investors, many of whom are still holding out hope that Microsoft will buy the Internet search pioneer lock, stock, and barrel, could potentially use Section 271 to bust up a sale of Yahoo's search assets to the Redmond giant. Yahoo, which is incorporated in Delaware, would likely fetch a lower sales price for selling just its search business, rather than selling the entire company.

Over the years, shareholders have occasionally tried this tactic with varying success. And in Yahoo's case, chances are slim that investors would prevail in such an effort, said Christine Hurt, a University of Illinois associate law professor.

"After a sale of its search business, it's not like Yahoo will be a completely different company. There'll still be Yahoo e-mail, messenger, and groups, for example," Hurt said.

The criteria the courts will weigh as to whether Section 271 applies and needs a shareholder vote is two-fold when it comes to the "substantially all" argument.

For starters, "substantially all" needs to be quantitative. And usually that means the asset has to account for a certain percentage of the company's total assets, or revenues, earnings, or sales, for example. In some cases that has translated into an asset that generated 50 to 75 percent of total revenues, legal experts said.

The other criteria that comes into play is the qualitative importance of the asset. For example, the asset, while a small slice of the overall revenue pie, may play an extremely important role in the strategic direction and future growth of the company, said J. Travis Laster of Abrams & Laster, a Delaware attorney.

"This is not a bright-line test, but a multifactor test," Laster said. "Let's say you have three buildings, and two are losing money and the third is making a lot of money and you sell the third one. You could have a potential for a (Section 271) lawsuit."

Yahoo is valued at nearly $48 billion, based on Microsoft's sweetened offer of $33 a share for the Internet search pioneer.

And of that pie, Yahoo's search business represents a $21 billion slice, or approximately 45 percent, said Sandeep Aggarwal, an analyst with Collins Stewart.

Based on other metrics, Yahoo's search business accounts for 35 percent of Yahoo's total revenues, or 44 percent of earnings before the deduction of interest, tax, and amortization expenses (EBITA).

While search is a significant part of Yahoo's business, it has other areas it can leverage for growth, Aggarwal noted.

"If they sell their search business, they could focus on display ads, where growth is accelerating, their communications assets and international business and investments," Aggarwal said.

The asset being sold has to represent a pretty big chunk of the business before the Delaware Chancery Court will hear the case, said Randall Thomas, a professor of law and business at Vanderbilt University who estimates about one such case goes before the court each year.

And of the few cases that do go before the court, about 9 out of 10 get shot down, Thomas estimates, noting it's because the quantitative and qualitative standards are tough to meet.

"Of the two, the quantitative test is easier for plaintiffs to prove. It's pretty cut and dry...the basic question is, 'are we selling the guts of the company?'" Thomas said. "For the qualitative, it may not be a big percentage of the company, but it may be a real important part of the company."

Precedence mixed
Law firm Potter Anderson & Corroon has a comprehensive paper on the Section 271 issue, citing several past cases.

In Katz v. Bregman, the Delaware Chancery Court found a proposed sale of the company's Canadian operations and related shift to a plastic drums manufacturer from a steel drum maker warranted a shareholder vote. The defendant's Canadian operations represented 51 percent of its assets and generated nearly 45 percent of its revenues. It also accounted for 52.4 percent of its pre-tax operating income.

The Delaware court, however, had a different view in the Gimbel v. Signal Cos. lawsuit. An investor group sought to block the sale of Signal's wholly owned subsidiary, Signal Oil and Gas. The subsidiary accounted for 26 percent of total assets of the parent company, accounted for 41 percent of its net worth, and generated 15 percent of total revenues.

Creative crafting of deal transactions has also made pushing Section 271 lawsuits more difficult.

"The reason why we haven't seen as many of these over the years is savvy dealmakers are making it so it won't appear as a sale of all or most of a company's assets," Hurt said.

She added that they're structuring the deal to appear as a merger, rather than a purchase of assets, or entering into joint ventures or partnerships--all in a move to avoid triggering a shareholder vote.

But even in partnerships or joint ventures, a shareholder vote could potentially be triggered if the companies are actually transferring ownership to the new entity, Hurt noted. If, for example, Microsoft and Yahoo transfer some of their assets into a joint venture and Yahoo holds less than a 50 percent stake in the new entity, Yahoo investors may seek to get the Delaware courts to rule that a shareholders vote is needed.

But if Yahoo only issues a short-term lease of its search business, or issues a license, thereby retaining full ownership of its assets, Yahoo investors will have to cool their heels.