Tuesday, February 05, 2008

"This is like a person who's completely lost his mind"

That's Joe Rosenberg's take on MSFT's bid for YHOO (Rosenberg is Chief Equity Strategist for Lowe's Corp., a major Wall Street heavy hitter, and MSFT shareholder). Close, Joe. It's not like that, it is that. Rosenberg continues:

It's absurd. They're not going to earn anything like a reasonable rate of return on their investment in Yahoo. It just doesn't make sense.

This deal would do more harm to Microsoft shareholders than any of its competitors can do to it," Rosenberg said. "The company has lost sight of its principal focus, which is to produce value for shareholders."

Hmm...I believe I may have mentioned that last part a gazillion times or so over the past few years.

Meanwhile, Ballmer and Liddell are busy talking up the synergies of this deal. "Synergies", btw, are what you point to when you can't provide any specific, reasonable, measurable basis under which this deal makes financial sense, especially for MSFT shareholders (otoh, YHOO ones make out like bandits).

As someone who has repeatedly called for MSFT to reduce its at times chronic overcapitalization and use that money to make smart, accretive acquisitions or return it to shareholders, I'm obviously not against them doing either per se. But if you're going to go the acquisition route, note the qualifiers: smart and accretive. Buying YHOO, imo, is neither. The company already agrees that it isn't the latter - at least not for two full fiscal years following a successful purchase, and even then "excludes a lot of the accounting and purchase accounting of one-off costs".

Ballmer is touting this deal as building on the successful momentum that Online has been able to generate. Huh? This deal is about failure, not momentum. Failure to spot the potential of this market space back in the late 90's. Failure to respond for YEARS while others staked out their now dominant positions. And failure over the past 4 years, since the company got "serious" about it, and spent $10B's directly (and likely at least that much again in R&D) in a failed attempt to catch up - or even generate a profit. Meanwhile, we have the failure of his previous massively expensive "emerging" bets to be anywhere near as attractive, or even to collectively payoff.

Then there's the issue of credibility. Why should we believe anything coming from the team responsible for that track record of successive failure, who initially said catching up would be a matter of 6-12 months (how'd that work out?), or who recently justified $6B more of our money going to buy AQNT by assuring us that most of the big pieces were now in place for success?

On the timing front, why now when MSFT was finally showing some organic business strength and attracting investors? In a heartbeat, perception of MSFT has gone from potential comeback kid to looking even more desperate and ineffective than ever versus GOOG. And on a more macro basis, why do this with the economy sliding into recession, with many forecasting an extended bear market, when GOOG is experiencing their first major revenue and earnings miss (finally beginning a process of unwinding their -  and most related company's - higher multiples), and consumer-facing entities in particular are likely to be hard hit? Was YHOO secretly getting stronger and more valuable despite their recent grim earnings call, layoff announcements, and nosediving stock price?

And what about valuation, a whopping 60% premium to market bid - some 66X earnings - for a company already trading at 2X the PE of MSFT and expected to actually shrink earnings next year despite operating in one of the industry's fastest growing segments? And given GOOG's miss the night before, YHOO was poised to drop significantly further on Friday. So then the real premium would have been more like 70%.

Then there's the impact on MSFT shareholders. You know, the folks who actually own this company? With $40's looking possible (assuming a better market) on the back of some long-awaited business improvement and stock momentum, why should we want to see that destroyed via an acquisition that negatively impacts EPS for at least FY 09, and probably FY 10 as well? Not to mention adds tremendous additional risk, uncertainty, etc. in the interim? Similarly, why would we want to see the past $20B+ of buybacks using our cash instantly reversed, thereby diluting our ownership interest all over again? If this really is worth betting the farm - which is what Ballmer has effectively done - why not make it an all cash offer like every other recent one? The company now says it plans to take on debt for the first time anyway to finance this deal, so that historical excuse no longer flies. And Ballmer's answer yesterday - that he wanted to avoid financial risk (in addition to market and technology risk) - is hogwash.  MSFT could easily make this an all cash offer, take on debt to fund the part not covered by cash, and then suspend the existing buybacks for the next couple of years to pay down the debt (or do just enough to neutralize normal ongoing dilution). There'd even be a beneficial tax writeoff. And YHOO has several equity interests that could be spun off in the interim to recoup at least another $10B (though you have to approach that carefully since the Chinese Alibaba stake in particular could be long term attractive). But instead, Ballmer et al plan to do what they always do: let Mikey - aka the average MSFT shareholder - eat it. Well, actually another orifice is involved...

And what about the business logic? Do two GOOG roadkill equal one GOOG killer? If not, is distant #2 sufficient to justify this investment over any reasonable timeframe? Or is it reliant on some asinine 1-2 decade payback period like say Xbox, or maybe 2-3 like IPTV? Are current MSFT/YHOO customers going to say, "Wow, this disruption and uncertainly has me really excited. I'm not going to jump ship to GOOG and simply watch and wait. Instead, I'm going to stick with you though the next couple of years of integration nightmares, false starts and confusion"? Are current GOOG customers going to say "I bet MSFT can integrate both entities and still do a better job for me than GOOG does currently. Sign me up"? Are YHOO's predominantly Silicon Valley/BSD/Open Source/Open System orientated leadership and engineers going to sit back and say "Thank God MSFT came to our rescue. I've always admired them so much, and can hardly wait to start taking orders from Redmond and being told to switch to their proprietary technology, versus simply walking down the block to XYZ tech leader or startup"? And who's going to do the major personnel cuts required to give this merger any chance of success? Ballmer, under whose leadership MSFT has turned into a top heavy, slow-moving, bloated bureaucracy? Is he suddenly going to reinvent himself as Al "Chainsaw" Dunlap and lop off 5000 plus employees minimum? What about the obvious duplication across almost every area? How do you consolidate effectively when you're primarily after the user base? Some pundits are saying "they'll just pick technology winners" in each category. Excellent. So if I'm the guy who was using YHOO mail, and MSFT selects Live Hotmail (or whatever it's being called this particular week) instead, they figure I'll just happily accept it? Are they frigtarded? In almost all the major areas, users either consciously or unconsciously made a choice. If you attempt to remove that choice, there will be pushback and defections. The most likely beneficiary of that is GOOG.

I also find myself getting reflective, and noting that with this move Ballmer will have blown through the entire cash pile that once reached ~$70B - and even taken on debt for the first time in MSFT history - while some competitors have invested far less (directly and via ongoing R&D) and yet now enjoy cash balances not far off MSFT's. What has been accomplished for all that cash and ongoing R&D investment? Is MSFT stronger? Are shareholders better off? Are customers happier? Are employees more motivated? Are the core products better thought of? What about the impact of this move on MSFT's existing businesses? You know, the ones they've done such a great job running to date that the banner "We uninstall Vista" is a differentiator for some PC shops, OS X continues to gain share, SQL Server just got delayed again, IE continues to lose dominance to Firefox, Nintendo continues to dominate and PS3 is threatening to finally outsell Xbox this past month (for the first time), the flash Zunes just got a quiet price drop (no doubt due to very poor sales), IPTV is still a non-factor to MSFT's overall results despite more than a decade and $10B's invested, etc. etc. etc. Are those areas going to get more or even less focus as MSFT goes further afield from its supposed core competence, vainly battling GOOG head-to-head? And what if the cash cows need to buy someone? With no cash left, does that mean MSFT goes further into debt? Or do they go without, while Online loses some more money for us?

I've discussed the concerns. Could this biggest of reckless big bets pay off? Sure, there's an outside chance it could succeed given a long enough timeframe (read decades), uncharacteristically brilliant MSFT execution, and GOOG somehow fumbling. Is that reason enough to do it? No. Were it $20-$30B, my answer might be different. Everything has value assuming the right price. More importantly, I'm getting really tired of "promising" emerging opportunities being turned into financial sinkholes by leadership's "strategies", and then being forced to underwrite desperate fourth quarter Hail Mary passes with either our cash or via dilution of our ownership (while comically hearing that there's still plenty of time left on the clock), all for the promise of a future touchdown which never materializes. MSFT shareholders are constantly being asked to underwrite massive investments for some future payoff, only to be told (when that future arrives) that the payoff is delayed and still more investments are required.

Here's how Ballmer sums up this deal:

We have been losing money. Our plan here would be to not lose money in the future

Shareholders who have held MSFT stock since he took over as CEO in 2000, are faced with the same dilemma. Maybe that's why so many are selling on this news. The rest should be hoping that this deal gets kiboshed - either by YHOO or via regulators.




A quick way to destroy my valuation target, not to mention the perception that you are a good company, is to go and throw your cash at a crappy acquisition target, paying 40x FCF in the process – and this is coming from someone who stuck up for Microsoft’s aQuantive and Facebook deals. Maybe this is all part of a brilliant plan on Microsoft’s part, but all I see is a massive expenditure of capital into a non-core industry where the company has no track record of success.


  • You've echo'd many of my sentiments, in far better specificity as is your usual style.

    My one quibble with your view is that online ad rev market can't be ignored. Microsoft, having shot itself in both hooves of its cash cows, has to gain a new hoof-hold. Strategically, it must convert online searchs/traffic to dollars. A successful integration of Yahoo (under normal circumstances) would be a strong tactical move.

    But I agree with you, success it not likely and, circumstances are far from normal.

    I'll re-iterate for the sake of consolidating discussion here where it better belongs:

    Microsoft's acquistion of Yahoo is the quintessential double-edged Caliburnus.

    It's an epic move. Success would bestow legendary 'gravitas'. The attempt is inevitable.

    The attempt is also highly, highly problematic for Microsoft, as everything pivots on execution for which Microsoft is notoriously inept.

    There are many things Yahoo does far better than does Google, increasingly in the quality of search results (though Google's quantity and reach is still broader), and customized news with stats. The jury is out on email, as Google's offering is improving rapidly. And seemingly everything Yahoo does outshines the comparable MSN offering, especially market share.

    So, it is attractive, for someone.

    But there seems little Microsoft can add except cash (read staying power) and maybe channels, and it isn't clear that's what Yahoo lacks most, but rather a profitable strategy (another Microsoft weakness). Fixing Yahoo seems to require a better understanding of online advertising and commerce, and frankly it isn't clear to me that anyone has that cornered; not Google, not Yahoo and not Acquantive/Microsoft/MSN (successful advertising management has often seemed a mystic craft benefiting more from luck and agility than from competance and foresight).

    If Microsoft had a track record of successfully integrating, acreting and growing its acquistions instead of just embalming them, and if it demonstrated better customer rapport, wasn't already spread too thin across diverse and poorly run LOBs, wasn't top-heavy with sycophants, and had good execution (of projects, not people), it could work.

    Then if the acquistion goes through, it is difficult to imagine some aspect of Microsoft not suffering significantly as its myopic focus is spread thinner and wider. Not paying attention to a $44B acquisition would be suicide, but losing focus on the other problems will also be suicide. Avoiding both is fraught with uncertainty, to put it charitably.

    It has attractive possibilities, arguably essential, that in the hands of an Oracle or Cisco would be an odds on bet. But in the hands of the Redmond "double down and bet bigger" echo-chamber.... well, one might be advised to sell their MSFT now and buy their bonds instead.

    When stepping out onto thin ice, it's best to shed weight and distribute evenly.

    By Anonymous Charles, at 10:06 AM  

  • Great analysis as always. And all I can say is that my head has been hurting since Friday. I can't fathom how the board, how BillG, or how we employees could let this happen. I want to picket outside 34 to show my disapproval. The deal is wrong, timing wrong, business model wrong, number wrong, company wrong...just a big bowl full of wrong.

    By Anonymous Anonymous, at 10:25 AM  

  • "My one quibble with your view is that online ad rev market can't be ignored."

    Didn't mean to suggest it should. MSFT was finally showing a little bit of success there - at least wrt marketshare. IMO, they should have continued on that path, kept looking to change the game by offering content owners a better deal (rather than being a me-too), and focused on profitability. With YHOO struggling, that gave them a good shot at becoming a profitable #2.

    By Blogger MSFTextrememakeover, at 11:07 AM  

  • "The company has lost sight of its principal focus, which is to produce value for shareholders."

    I utterly despise that entire premise and nothing spells disaster for a company more than switching into that "bottom line" mode of thinking. The entire reason Google and Apple are kicking Microsoft's ass all over the place in the search, ad and media is because their bottom line is to innovate, create and excel.

    Let me tell you how inspired the developers and designers, which are the life-blood of Microsoft, are going to be when they find out their project's mission statement is to increase shareholder value. Managers are pretty much worthless without anyone to manage and the best talent is going to leave without any new blood to fill their shoes because talent never wants to work for "shareholder value". Soon Microsoft is only going to be left with an army of worthless managers with no one to mange except cut-rate teams and stacks of resignations.

    Nothing should make a shareholder worry more than when their investment says their primary focus is the shareholders. You don't invest in people that think like you do, you invest in things that look forward, that think in terms of decades, that have visions of something greater. If you want to invest in something safe that has the shareholder in mind you might as well just get some mutual funds and sit back in your rocker and recount the old days.

    And yes, I am a shareholder.

    All that said I don't see much value in a Y! acquisition and would much rather have seen a partnership than a hostile bid.

    By Blogger Shawn Oster, at 11:12 AM  

  • In one fell swoop Ballmer has effectively tied Microsoft's hand for any really innovation forward. The idea of buying a company that might as well be on life support because of like synergies is irresponsible. As I said in my post the other day Microsoft is beginning to resemble a 10,000 chicken with its head cut off -

    By Anonymous StevenHodson, at 11:32 AM  

  • "I utterly despise that entire premise and nothing spells disaster for a company more than switching into that "bottom line" mode of thinking."

    I think you're interpreting it too narrowly - as many often do. Within reason, the profit incentive is the basis of capitalism. And enhancing shareholder value is the primary charter for the leadership of a public company - Rosenberg is simply stating fact. That said, for me (and likely him too) it doesn't negate any of your very well argued points about what it takes to actually accomplish that goal over the long term (innovation, motivating your employees, thrilling customers, etc.), nor the ongoing trade offs required between maximizing short term results and ensuring long term success. Yes, becoming too short-term bottom line orientated is a danger - as you point out. But so is the other end of that spectrum - as he points out.

    By Blogger MSFTextrememakeover, at 12:15 PM  

  • If you want to invest in something safe that has the shareholder in mind you might as well just get some mutual funds and sit back in your rocker and recount the old days.

    Customers "invest" in Microsoft as well. Major commitments to a vendor are made, in part, on perceptions of a vendors financial health, measured in large part on stock valuation, right or wrong.

    A falling MSFT will soon delay if not cancel long term plans to rollout Microsoft-based solutions to IT systems.

    Don't kid yourself that share price (i.e. having the shareholder in mind) doesn't directly influence buying decisions. Nobody buys from a loser.

    By Anonymous Charles, at 1:40 PM  

  • Didn't mean to suggest it should.

    I misunderstood.

    IMO, they should have continued on that path, kept looking to change the game by offering content owners a better deal (rather than being a me-too), and focused on profitability.

    I suspect they looked down that path, foresaw a difficulty in convincing content owners and ad agencies that MSN could bring the traffic soon enough to matter. If they could buy or take Yahoo's traffic, that proposition becomes more plausible to matter in ad decisions.

    Whether it remains plausible given the uncertainties cited by all, is, well, uncertain. The key is how do ad agencies and content owners react to this prospect - they probably have an insightful take.

    By Anonymous Charles, at 1:58 PM  

  • I as a value investor, Microsoft shareholder and ex-microsoftie hereby declare to divest from Microsoft. I have had enough with the monkey leadership.

    By Blogger Vikas Agarwal, at 4:04 PM  

  • Ballmer needs to be taken down pronto. This clown and his total madness has made YHOO stock to go up 10 bucks in a week while MSFT has gone down 4 bucks in the exact same period.
    In addition, there is not a single credible piece of media that doesn't speak of desperation or open realization that our online strategy is a complete fiasco unable to compete. So our stock future doesn't look any brighter. It's time not to sell but to leave. Well done monkey boy. Keep it up.

    By Anonymous Anonymous, at 12:24 AM  

  • A good negotiator (poker player) would take the offer off the table immediately and let Yahoo flounder awhile and then offer $21.

    As a long-time shareholder, I read all of these posts as disturbingly close to my thoughts.

    An aside, this is very similar to the Mariner's recent dealings with the Orioles for Eric Bedard. (Giving up huge for an ace--I hope, I hope)

    By Anonymous Anonymous, at 8:05 AM  

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