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2HRS2GO: No point in wedding Yahoo! and eBay

All it takes is a whiff of big-time M&A to get traders going.

The market roiled following CNBC's report of negotiations on a merger or alliance between Yahoo! (Nasdaq: YHOO) and eBay (Nasdaq: EBAY). In a perverse way, you can see how the idea excites people: shares of both companies plunged more than 5 percent today after the Financial Times of London reported Yahoo! and eBay gave up after preliminary talks last week.

Buzz about a Yahoo!-eBay combination has circulated for quite awhile without being fulfilled, which makes today's shareholder disappointment a bit puzzling even if you account for the obvious power of CNBC.

More perplexing is why the idea continues to fascinate people.



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We know Internet shareholders won't accept anything that isn't an obvious and sizable profit. Yet even with today's decline, eBay carries a market capitalization of more than $25 billion. A 50 percent premium means a price tag of almost $38 billion. Using yesterday's eBay cap of $27.3 billion, you're looking at $41 billion of shares in an all-stock deal. That's nearly half of Yahoo!'s current value.

Merrill Lynch analyst Henry Blodget believes a deal could be done. In a research note released this morning, Blodget asserts Yahoo! can pay eBay as much as $300 a share, or a 42 percent premium from yesterday, and still avoid dilution.

Based on Tuesday's closing prices and using Merrill's current estimates for the separate companies, Blodget expects a combined Yahoo!-eBay would have about 940.5 million shares outstanding in 2001 and adjusted pro forma net income of $483.5 million, or 51 cents per share, not including special charges and amortization. That 51 cents figure happens to be what Blodget is already predicting for Yahoo! next year.

Assuming Yahoo!-eBay blows out estimates by 60 percent -- certainly possible given the companies' history of consistently topping forecasts -- a $300-per-share deal ends up just barely dilutive (1.3 percent in Blodget's model) in 2001.

Both of Blodget's (guess)timates hinge on cutting the combined company's operating expenses by 10 percent, or $130 million. "We believe that Yahoo! and eBay have substantial overlap in sales and marketing and in general and administrative functions," the Merrill analyst writes.

I wonder about that. eBay and Yahoo! analysts gush over the strong financial management of both companies, so how much fat is there to cut? Is Yahoo!'s salesforce able to handle the additional requirements of eBay's business? Can you eliminate the entire administrative operation of an eBay business expected to generate revenue of $544 million next year?

If you assume a smaller 5 percent expense reduction -- also not unreasonable given that any eBay-Yahoo! merger would surely be portrayed as a growth deal rather than a cost-cutting one -- Blodget's $300-per-eBay-share model predicts the combined company would see 2001 EPS dilution somewhere between 4.3 and 7.2 percent, depending on which set of earnings estimates you use.

In other words, a more conservative assumption means this deal won't boost EPS until 2002 at the earliest. On that basis, it doesn't seem likely Tim Koogle & Co. would be inclined to make the purchase. Yahoo! generally restricts itself to immediately accretive deals.

Even if Yahoo! was interested, Blodget's model relies on an eBay premium of 42 percent, which seems rather low. Granted, a $300 price looks better now because of eBay's decline today, but we're still dealing with the model's assumptions, which are based on yesterday's price.

Those cost concerns by themselves are enough to throw any eBay deal into question. But price notwithstanding, it's worth asking if the strategic rationale is strong to begin with.

You can see why Yahoo! might want eBay's commerce engines, both in auctions and online payment technology. But $40-plus billion seems an awful lot to pay -- it's not as if eBay's credit card system is the only one out there.

And what does Yahoo! give eBay? "We believe Yahoo!'s enormous reach, international operations, and content and communications capabilities would strengthen eBay's platform," Blodget says.

eBay can get all that through deals such as its America Online (NYSE: AOL) partnership. The auctioneer certainly doesn't need cash; although its operations lose money, eBay subsidizes that through its investment and interest income. That's why eBay has reported a net profit every quarter since going public. CEO Meg Whitman loves to point out eBay still hasn't spent its initial VC dollars.

Absurd market pressures are the only reason Yahoo-eBay! even gets mentioned -- shareholders and traders want a sexy deal. Unfortunately, hot sex by itself never justifies marriage. 22GO>