"Don't think you're on the right road just because it's a well-beaten path"
Author Unknown

I guess I have neglected to state my opinion on many of the questions of the week at the SLO-2- so here is a short summary of my thoughts for what's its worth...

First on the YHOO/MSFT deal- let's cut through the BS- in my opinion -Yahoo's business model is fundamentally broken and thus whoever ends up buying it is likely to overpay- period. To me YHOO has always been a company that had some great ideas and products, but without solid execution- great ideas are simply a day dream as someone once said...

I am not sure one needs to look any further than a summary of Yahoo's acquisitions profiled at WSJ last week, to quickly see why this stock declined to $19 a share in the first place. Earnings growth in the last few years has been anemic at best and outright negative at worst. And with EV/EBITDA ratio of almost 30 times, the standalone valuation (even after adjusting for value of certain investments) simply seems unreasonable. It is true that company generates roughly $1.5B in cash each year and advertising revenue from most of company owned properties continue to grow but is enough to justify $40B market cap?

Now back to some of the investments themselves- here are some of examples of why the decline to $19 a share wasn't so unreasonable...In 1999 Yhoo bought Geocities for roughly $3B trying to corner the Social Networking market- what is it worth now? I doubt very much if anything at all. Facebook and MySpace have simply outplayed them in every direction...

What's next- Broadcast.com- $4.3B of shareholder value- vanished- the web site has been simply shut down...How about search? Inktomi and Overture- $2B+ more- this time not quite "gone with the wind", but unlikely worth full 4 times the annual income of the entire company. How about well publicized "Panama" investment? I don't know what the total $ amount spent was, but it is now almost a certainty that the platform has failed to live up to all the hyped expectation, with affiliate advertising revenues actually declining y-o-y...So all-in-all an astounding 10+ years worth of earnings- could now be considered almost worthless...

To be fair, one does need to mention some of the investments that on the surface seem to have been more succesful- with the best example being probably Alibaba.com. Yhoo's current stake in the Chinese company is worth several billion dollars, but it is not yet clear to me how could the company recognize all the "headline" value from this investment without a significant discount, plus given the "frothiness" of the Chinese markets in general, future upside there could be hard to come by...

It is also true that several of Yahoo web properties like Yahoo Finance and Yahoo Mail represent some of the most valuable real estate on the web, period, but in my humble opinion- they have a terrible job so far monetizing these assets in any significant way. Earnings growth is simply not there any more-forget all the "one time" investment and adjustments stories- after a certain point they simply become too recurring to be considered "one time". It is very hard to see where will the growth come from?

What's more, as a vivid Yahoo user myself - I can tell you that the quality of the content is not getting any better or actually might be even getting worse- it seems like the recent cost cuts are impacting it very negatively. For example, in my experience, Yahoo Finance web site in the last 12 months has been plagued with constant glitches, when prices and various multiples are simply not showing up at all for prolonged periods of time, or are simply corrupted; Finance message boards became pretty much worthless with spammers overrunning and outnumbering the legitimate users; Yahoo Mail, while certainly very popular, simply has too much solid competition to be a real earnings growth engine in the future- plus it's virtually free and thus is not likely to deliver significant value on it's own anyway...

So, to sum all of the above- standalone YHOO is not GOOG or EBAY and not even an AMZN, and their pre Microsoft offer price reflected the true value of the company... In my opinion Yahoo's management has made a fundamental strategic mistake of trying to be all things to all people and never really chose to specialze in anything...

They've tried to beat EBAY and AMZN in e-commerce and failed... The tried to corner the Social Networking space with Geocities- and lost to Facebook and MySpace...Same thing in search -GOOG has simply ate their lunch...Now both Yahoo Mail and Yahoo Finance are likely to stay under pressure and without substantial additional investment and focused management attention, they might just lose there again to the likes of GOOG and MSFT...

That brings us back to the fundamental question - is MSFT really getting anywhere close to a good deal by offering a whopping 60% premium for a company with a fundamentally broken or undefined business model? The answer to this question in my opinion is again relatively simple- even if MSFT is serious in their intent of eliminating a $1B+ in costs- the deal might be at best an "ok" proposition to MSFT's shareholders. One would expect that eliminating duplicate development resources deployed to Search engine development etc could help justify some of the premium, but $1B is probably worth $10B or so at best (an NPV at 10% WACC), given all the costs and time it is likely to take to capture the savings...

I also do think that MSFT's management is more competent and shareholder friendly and thus could justify some additional valuation upside. But given the complexity of the Yahoo structure (Alibaba, Yahoo Japan investments etc), heavy reliance on synergies to make this deal accretive to MSFT (by the way why would Yahoo's shareholders should receive these synergies upfront instead of MSFT's anyway?) and the enormous pressure from the Wall Street on MSFT to increase the bid (again no financial justification whatsoever)- this deal is not good for MSFT's shareholders and thus the decline in MSFT's price, assuming the deal closes at the announced price or higher, to me is definitely justified...The question is now simply -at what point will this punishment become unreasonable? I think that if MSFT sticks to the original price or pulls out- stock should react positively, in all other cases- more declines could be in store.

So take it for what's it worth and remember this is an opinion only...

P.S. I am not trying intentionally to be skeptical, may be just a little more objective then most of the Main Street Press :)
www.skepticalcapitalist.com