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The UK’s Times Online is reporting that “Microsoft is in talks to acquire Yahoo’s online search business for $20 billion.” The report is filled with lots of juicy, specific details that lend it credence, but don’t make a lot of sense when you drill down into them.
The new deal, according to the Times Online, is a complex transaction that involves Microsoft supporting a new management team made up of former AOL CEO Jonathan Miller and former Fox Interactive Media president Ross Levinsohn, who are investing partners at Velocity Interactive Group. Levinsohn, however, tells VentureBeat there is “no truth” to the story. (Although there were rumors a while back that Microsoft wanted Levinsohn and Miller to run Yahoo, which is where this might be coming from).
And unlike Microsoft’s earlier offer to buy Yahoo’s search business outright, this one is for a long-term operating agreement. In fact, the $20 billion deal that sells the story in the headline is a red herring that refers to a call option that is part of the supposed deal. Here is how the story actually describes the supposed terms of the deal:
Under the terms of the proposed transaction, Microsoft would provide a $5 billion facility to the Miller and Levinsohn management team. The duo would raise an additional $5 billion from external investors.
This cash would be used to buy convertible preference shares and warrants which would give it a holding in excess of 30% of Yahoo.
The external investors would also have the right to appoint three of Yahoo’s 11 board directors. The talks with Yahoo involve Microsoft obtaining a 10-year operating agreement to manage the search business. It would also receive a two-year call option to buy the search business for $20 billion. That would leave Yahoo to run its own e-mail, messaging, and content services.
It is expected that the operating agreement would boost Yahoo’s income by as much as $2 billion per annum.
So the deal is really that Microsoft would put up $5 billion to help a new management team buy preferred shares and warrants that would give it a 30% stake in Yahoo. In return, Microsoft would get a 10-year operating agreement to run Yahoo’s search business.
Let’s just compare this to the deal Microsoft previously offered to buy Yahoo’s search business outright.
That involved an $8 billion direct investment in Yahoo in exchange for 16% of the company, plus $1 billion in cash for the search business. And that was expected to generate an extra $1 billion in operating income.
So how does the new deal generate twice as much income going into an economic downturn? And why would Microsoft agree to anything other than complete ownership of Yahoo’s search business? And how does the search business go from being worth $1 billion earlier this year to $20 billion in two years?
Like I said, it doesn’t make much sense.
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Bureaucracy kills innovation. We all know that. But why? Partly, it’s because bureaucracy grows out of prudence, a desire not to repeat the mistakes of the past. With the current economic crisis, for example, you can be sure that a lot more checks will be put into place—both in Washington and in corporate boardrooms—to prevent the excesses that got us into this situation from happening again. Governments and corporations alike react to crises by implementing more rules and regulations.
Putting checks in place, after all, is the prudent thing to do. But bureaucracies, and the checks they impose on companies, have their unintended consequences. Paul Graham takes a stab at exploring these costs in a new essay. He writes:
Every check has a cost.
. . . Checks instituted by governments can cripple a country’s whole economy. Up till about 1400, China was richer and more technologically advanced than Europe. One reason Europe pulled ahead was that the Chinese government restricted long trading voyages. So it was left to the Europeans to explore and eventually to dominate the rest of the world, including China.
In more recent times, Sarbanes-Oxley has practically destroyed the US IPO market. That wasn’t the intention of the legislators who wrote it. They just wanted to add a few more checks on public companies. But they forgot to consider the cost. They forgot that companies about to go public are usually rather stretched, and that the weight of a few extra checks that might be easy for General Electric to bear are enough to prevent younger companies from being public at all.
The bureaucracy of large corporations can be just as bad. He gives the examples of checking to make sure suppliers are solvent before allowing them to bid for business or approving large software purchases by committee. On the surface, these are prudent precautions, but they end up imposing costs that also need to be taken into account:
The purpose of the committee is presumably to ensure that the company doesn’t waste money. And yet the result is that the company pays 10 times as much.
Checks on purchases will always be expensive, because the harder it is to sell something to you, the more it has to cost.
Suppliers, whether they are plastic manufacturers or software vendors, will incorporate the cost of complying with bureaucracy into their price. And it is not just outside vendors that make this calculation. So do employees. Throw too many rules at the employees who create your product and the most talented ones may decide it is not worth their while. Graham gives the example of software programmers frustrated by longer release schedules after their startup has been acquired by a larger company with more rules in place. He warns:
And just as the greatest danger of being hard to sell to is not that you overpay but that the best suppliers won’t even sell to you, the greatest danger of applying too many checks to your programmers is not that you’ll make them unproductive, but that good programmers won’t even want to work for you.
This is the cost of prudence. Sometimes it is worth it, sometimes it is not. Releasing software that actually works might be better than releasing early and releasing often, depending on what type of software it is and on your customers’ tolerance for failure. Stronger rules regulating the buying and selling of credit derivatives would have definitely been in the “worth it” category. Imposing Sarbanes-Oxley equally across companies both big and small was overkill.
Rules need to be judged not only by what they are designed to accomplish or protect against, but also by the hidden costs they end up imposing on everyone who follows them.
(Photo by redjar).
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Carl Icahn bought up another 6.8 million shares of Yahoo earlier this week, bringing his total holdings to 75.6 million shares (just shy of 5 percent). He paid just under $10 a share, or about a third of what he paid last May when he started building the bulk of his position.
Of course, now he controls three seats on Yahoo’s board, including the one he occupies. So he is personally involved in the search for a new CEO to replace Jerry Yang, and he knows the stock will probably react favorably to the announcement of any new leadership. Why not buy now before the news when the stock is hitting rock bottom? He is obviously in the stock for the long haul now.
I wouldn’t read too much into this move other than that Icahn is in too deep with Yahoo to bail out now. If you are committed to a stock, you buy it when it’s cheap.
It doesn’t mean that Yahoo has found a new CEO. If the search was over and Icahn knew who was going to take over, that might be considered insider information and Icahn wouldn’t be able to trade on that knowledge.
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