IT Spot

This is the text of the e-mail Yahoo Chief Executive Jerry Yang sent to his company’s staff Saturday after Microsoft withdrew its offer to acquire the Internet pioneer.

From: jerry yang

To: [Yahoo Employees]

Sent: Sat May 03 19:26 2008

Subject: today’s news

yahoos,

today microsoft announced that it has withdrawn its proposal to acquire yahoo!. from the beginning of this process, our independent board and leadership team have maintained that microsoft’s offer undervalues the company, and we’re pleased that many of our shareholders agreed with us. our board and leadership team now remain focused on maximizing shareholder value and pursuing strategic opportunities that position us for success and leadership in our markets.

of course, we anticipate that microsoft’s announcement will draw media attention and speculation as to what happens next for yahoo!. that means the spotlight will be on us - just as it has been for the past three months. i’m incredibly proud of how we’ve performed under such scrutiny, with last quarter’s great financial results as a testament to everyone’s hard work and focus. just as we did last quarter, now is the time for us to shine and show what we’re made of.

with the distraction of microsoft’s unsolicited proposal behind us, we must redouble our efforts. we should focus our energies on continuing to execute the most important transition in our history. how will we do this? by executing against the strategies and priorities we already have in place, and by continuing to deliver indispensable experiences for our communities of users, advertisers, publishers and developers.

in the end, it all comes back to who we are as a company. we have a spirit and a culture that is uniquely yahoo! - and we can’t forget that. staying true to who we are has helped us pull through the recent uncertainty we’ve faced, and will continue to be an asset as we move ahead. there’s a reason why we’re the only fortune 500 company with an exclamation point at the end of our name, and now is the time to demonstrate what that exclamation point stands for.

over the next several weeks, sue and i plan to visit as many offices as we can to thank you in-person for everything you’ve done and continue to do for yahoo!. we hope you’re as excited as we are about the future that lies ahead for all of us — together as one yahoo!.

jerry

Despite a brief moment of optimism heading into Saturday, Microsoft and Yahoo were really never closer to doing a merger deal than two ships passing in the night.

There was almost no discussion of price, and those talks that were held suggested Yahoo was never really prepared to sell itself to Microsoft, according to a source familiar close to the negotiations.

Although Microsoft made its on February 1, the first substantive meeting didn’t take place until April 15–10 days after Microsoft set a three-week deadline for Yahoo to come to the negotiating table. At that meeting, which was initiated by Yahoo and held in Portland, Ore., Yahoo went through its own revised business forecast as well as some non-price-related deal terms.

Asked by Microsoft CEO Steve Ballmer where Yahoo stood on a takeover price, Yahoo executives responded that they didn’t really have one. On April 18, there was a follow-up call with five bankers representing the two companies. Yahoo’s bankers indicated during the call that the company was only prepared to do a friendly deal at $40 a share or higher. That was the only discussion on price until this week, the source said.

Yahoo indicated to Microsoft this week that it might be willing to do a deal at a price lower than $40, and Microsoft later told Yahoo that it was will to increase its offer by a couple dollars a share. On Friday, Microsoft said it was willing to offer $33 a share, which it viewed as a substantial increase from its original offer given that the original cash-and-stock offer had dropped below $30 a share.

The two sides arranged agreed to meet face to face at Seattle’s Sea-Tac airport to discuss the revised positions. Microsoft and its bankers headed into the meeting with a fair bit of optimism given that they believed Yahoo shareholders were willing to do a deal at close to Microsoft’s improved offer of $33 a share. However, at the meeting, Yahoo co-founders Jerry Yang and David Filo said their board was willing to do a deal around $37 a share, but that they would rather see a deal at around $38 a share.

The disagreements were not confined to price, the source said. Shortly after the April 15 Portland meeting, Yahoo gave Microsoft a list of nonfinancial deal terms.

“They were complete non-starters,” the source said.

Yahoo also wanted Microsoft to go through an antitrust review that Microsoft believed would have take several months to complete.

“Jerry didn’t want to sell the company,” the source said.

The source declined to go into specifics regarding Yahoo’s demand for review, but said the two sides were as far apart on nonfinancial issues as they were on financial ones.

My friend Marc Canter has written a series of blog posts outlining the issues, constructs, technologies and standards required to build out an “open mesh,” as he put it. It’s a kind of unified field theory for the Web.

Marc Canter

(Credit: Dan Farber)

Canter has been an evangelist for a Web without walled gardens. He also has a financial stake in the open mesh. He runs a company, Broadband Mechanics, that has developed a white label social network and Web site creation service that depends on open standards.

The open mesh not Microsoft’s Live Mesh. The open mesh is “made up of vendors, standards and glue code - that connects a wide range of services, applications and platforms together,” Marc said. And, it has identity at the center:

“The key foundation set of constructs, web services and APIs to support when building the mesh - is the area of profiles, personas, friendships, relationships, social graphs and groups. It all starts with humans and every construct, element and component of the open social web we’re building has to do with people.”

ID is at the center of the open mesh.

(Credit: Marc Canter)

“Coming out of all this is an awareness of a new kind of infrastructure - which simulates the blood veins, nervous systems, skeletons, fire hose and neural networks of the open mesh. Its about RSS, Friendfeeds, XMPP, attention, two-way APIs, OpenID, DNS-like backbones and an international approach.”

Canter recognizes that a completely unified and open mesh is more theory than practice:

“No one wants to give up control of their technology - so (by definition) the open mesh must be made up of a combination of open, free protocols and technologies with proprietary APIs and technologies.”

At this juncture the underlying plumbing, or mesh, for the social Web is under construction. It’s a good time to bring the issues to the forefront, before the mesh blocks out more than it lets in.

In a special edition of the Gillmor Gang, Steve Gillmor, Mike Arrington, Doc Searls, Dana Gardner, Robert Anderson, Robert Scoble and I discuss Microsoft’s decision to walk away from its bid to acquire Yahoo.

The consensus: Google is a big winner, Microsoft is not dead and lives to bid another day and Yahoo better be able to execute with precision on its strategy or it faces difficult times and a less lucrative result for shareholders.

Listen to the show

Curious how Microsoft’s multi-multi-multi-billion dollar buyout bid for Yahoo sputtered, then crashed?

Kara Swisher’s BoomTown column in All Things Digital has an interesting account of the missteps, sidesteps, and other goings on between the parties over the past several weeks.

Here’s some nuggets from Swisher’s post:

April 15 - Yahoo trotted out its financial strategy dog-and-pony show in Portland, Ore., to Microsoft. Trouble is, they remained mum on a valuation for the Internet search pioneer.

April 18 - The magic figure of $40 a share is revealed during a conference call with the companies’ bankers and advisors. That went over like a ton of bricks and the software giant begins to craft plans for a proxy fight.

April 29 - Seeking to keep Microsoft from going hostile with a proxy fight, Yahoo chief executive Jerry Yang and chairman Roy Bostock held two phone calls with Microsoft CEO Steve Ballmer, where they offered up other deal alternatives to a merger, such as a search partnership.

April 30 - Yang offers up $38 per share to clinch the deal, during a face-to-face meeting in Silicon Valley. Yang continues to raise the issue of possible anti-trust regulatory rope hanging a Microhoo deal. Also suggested a deal like Google’s adSearch test.

May 3 - Yang, joined by his college bud and Yahoo co-founder David Filo, meet Ballmer and Microsoft executive Kevin Johnson in Seattle. Microsoft upped its offer to $33 per share and Yang came down to $37 a share. But the kicker was Yang’s threat: If Microsoft launched a proxy fight, Yahoo would pursue a Google deal to outsource its online ad business.

And so, it concluded with a see ya from Microsoft, which officially withdrew its offer…maybe as Yang and Filo were boarding their return flight home…

Apparently Yahoo wasn’t just bluffing with its plan for an ad deal with rival Google.

The search company had planned to announce the partnership by midweek, a source familiar with the plan said. Under the deal, Google would supply text ads next to Yahoo search results; Yahoo conducted a limited-scope test of the Google ads for two weeks in April.

How exactly the potential partnership could come to fruition remains unclear with Microsoft walking away from its Yahoo acquisition offer.

On the one hand, Microsoft’s withdrawal reduces some urgency and gives Yahoo more flexibility to chart its own course. On the other hand, Microsoft’s attempt to acquire Yahoo has raised shareholder expectations for where the search pioneer’s stock price should be.

Citigroup analyst Mark Mahaney and colleagues estimated in a February report that Yahoo makes less than 4 cents per click on its search ads to more than 9 cents for Google, so sharing could help Yahoo generate more cash and help Google deliver more ads.

Pairing the No. 1 and No. 2 search-ad companies could raise antitrust issues, but Yahoo had planned to address the situation by offering an open system in which others besides just Google could offer ads, the source said. It would employ a dynamic bidding system that would place the ad that would generate the highest revenue. It’s unclear whether Yahoo has extended any offers to others, such as Microsoft, to participate.

Yahoo declined to comment on the planned announcement.

Microsoft Chief Executive Steve Ballmer was not so restrained. In a letter to Yahoo Chief Executive Jerry Yang Saturday, Ballmer criticized the Google ad deal as a key reason the company didn’t want to make a “hostile” bid to acquire Yahoo.

“Our discussions with you have led us to conclude that, in the interim, you would take steps that would make Yahoo undesirable as an acquisition for Microsoft,” Ballmer said. The deal would undermine Yahoo’s own ad system, make it hard to retain employees, and increase Google’s power in search ads even more, he said.

Here’s the full text of Yahoo’s response after Microsoft withdrew its offer to acquire the company.

Chairman Roy Bostock: We remain focused on maximizing shareholder value and pursuing strategic opportunities that position Yahoo for success and leadership in its markets. From the beginning of this process, our independent board and our management have been steadfast in our belief that Microsoft’s offer undervalued the company and we are pleased that so many of our shareholders joined us in expressing that view. Yahoo is profitable, growing, and executing well on its strategic plan to capture the large opportunities in the relatively young online advertising market. Our solid results for the first quarter of 2008 and increased full year 2008 operating cash flow outlook reflect the progress the company is making. Today, Yahoo has:

• a refined strategic focus to drive enhanced volume and yield;

• reorganized to focus its efforts on its most promising products and services;

• invested in innovations designed to revolutionize display advertising and facilitate closing the competitive gap in search; and

• enhanced expense and resource management to support improved profitability.

CEO and co-founder Jerry Yang: I am incredibly proud of the way our team has come together over the last three months. This process has underscored our unique and valuable strategic position. With the distraction of Microsoft’s unsolicited proposal now behind us, we will be able to focus all of our energies on executing the most important transition in our history so that we can maximize our potential to the benefit of our shareholders, employees, partners and users.

With Microsoft’s withdraw of its increased Yahoo bid on Saturday, the Internet search pioneer’s two largest institutional investors are fuming, according to a source familiar with their thinking.

The two investors were willing to accept an offer of $34 a share, the source noted. Microsoft was offering an increased bid of $33.

“Yahoo over played its hand,” said the source. “If Yahoo’s two largest investors are willing to take $34 and Microsoft is willing to give $33, it’s a lot closer than Yahoo’s $37 (a share).”

Capital World Investors, which recently doubled its holdings in Yahoo, bringing it to a 10.1 percent stake and Capital Research Global Investors, which holds nearly a 6.4 percent stake, are Yahoo’s two largest institutional investors.

The two institutional investors, which are part of The Capital Group Companies, own a combined 16.5 percent stake in Yahoo.

On Monday, when the markets open, Yahoo’s shares, which closed Friday at $28.67, up nearly 7 percent, are likely to feel the pressure.

It would not be surprising to see Yahoo’s stock fall to $25 to $24 a share, said sources familiar with the negotiations, as well as the institutional investors thinking.

“I don’t think the stock will go back to $19, but it may fall to $24 or $25 a share,” said a source familiar with Yahoo’s negotiations.

On the day before Microsoft publicly announced its unsolicited cash and stock buyout bid for Yahoo, the Internet search pioneer’s stock closed at $19.18 a share.

While Yahoo’s two largest institutional investors own a larger stake in Microsoft than Yahoo, the Internet search pioneer’s third largest stake holder, Legg Mason, is a Yahoo pure play - owning no Microsoft shares.

Legg Mason has previously publicly supported Yahoo in its efforts to land a buyout bid beyond Microsoft’s initial offer. Legg Mason was among roughly half a dozen of Yahoo’s largest shareholders who were heavily wooed by both companies this past week.

Nonetheless, Yahoo may find itself facing more than just pressure on its stock come Monday.

“They’ll get a call tomorrow. I’m shocked this deal didn’t get done. They’re idiots,” said a source familiar with the investors thinking.

Update 7:35 p.m.: I added more detail about Microsoft’s maximum bid and Yahoo’s minimum requirement.

Microsoft just wasn’t willing to pay enough for Yahoo to make the deal worthwhile, the company said Saturday.

“From the beginning of this process, our independent board and our management have been steadfast in our belief that Microsoft’s offer undervalued the company and we are pleased that so many of our shareholders joined us in expressing that view,” Yahoo Chairman Roy Bostock said in a statement.

Microsoft withdrew its offer to acquire Yahoo after increasing its $31-per-share cash-and-stock bid to $33. Yahoo evidently thought that too low–Microsoft Chief Executive Steve Ballmer said Yahoo wouldn’t go below $37.

Bostock also indicated that Yahoo thinks it can grow just fine on its own, even if he didn’t declare Yahoo restored to financial vigor. However, but didn’t share specifics about what’s next for the company.

“Yahoo is profitable, growing, and executing well on its strategic plan to capture the large opportunities in the relatively young online advertising market. Our solid results for the first quarter of 2008 and increased full year 2008 operating cash flow outlook reflect the progress the company is making,” he said.

It’s quite possible Microsoft will return again for another bid–particularly if Yahoo’s share price plunges and the purportedly loyal shareholders agitate for fast change. But Chief Executive Jerry Yang was willing to call the Microhoo saga at an end.

“With the distraction of Microsoft’s unsolicited proposal now behind us, we will be able to focus all of our energies on executing the most important transition in our history so that we can maximize our potential to the benefit of our shareholders, employees, partners and users,” Yang said in a statement.

Now might be a good time for Yahoo to show some evidence of the merits of all those “strategic alternatives” it’s been pursuing.

On Saturday, Microsoft formally withdrew its offer to acquire the search pioneer, at least for now. So what happens next for Yahoo?

There are a handful of clear options: stick to the current plan, strike a deal with Time Warner to acquire AOL, outsource some search advertising to Google.

This last option is certainly on the short list of possibilities: Yahoo conducted a two-week test that used Google’s higher-revenue system for placing text advertisements next to search results. Gartner analyst Allen Weiner sees it as the most likely future for Yahoo.

“Google is the powerhouse that could turn them,” he said. “Yahoo is still the No. 1 Web traffic company in the world, and Google is the No. 1 search and ad company. That’s an interesting combination. If they could figure a way to work together and work within the law, I think that’s their best bet.”

But relying on Google for ads, even in a limited way, is in effect admitting defeat in a key part of Yahoo’s business. Even if it gets more money from the higher revenue per click generated by Google’s ad technology, relying on its biggest adversary raises the possibility that a central part of the company’s business could be hollowed out.

Evidently Yahoo Chief Executive Jerry Yang has evaluated the possibilities carefully and saw a Google ad deal as a lesser evil to joining forces with Microsoft.

Microsoft CEO Steve Ballmer saw the Google possibility as a poison pill of another kind. “We regard with particular concern your apparent planning to respond to a ‘hostile’ bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo! today. In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo undesirable to us.”

Of course, with Microsoft walking away from Yahoo, Yahoo could walk away from Google. For that strategy to be successful in the long run, Yahoo would have to reverse the steady market share losses to Google in search ads and to strengthen its display-ad business.

And it’s not a great market for a turnaround. Yahoo will have to prove its advertising merits during an economic slowdown that so far has left Google unfazed.

All these options, though, must be assessed in light of the company’s stock performance on Monday.

Yahoo faces a potentially frosty splash of cold water if Wall Street sends shares down toward $19.18, where they were trading before Microsoft launched its attempt to acquire Yahoo; on Friday, the stock closed at $28.67 after negotiations with Microsoft restarted. Without Microsoft offering a convenient assessment of Yahoo’s worth, shareholders will have to reassess Yahoo’s ability to build its stock up to that level on its own

A serious decline in value is in effect a major vote of no confidence that could help restart a new Microsoft offer. Chief Executive Jerry Yang, already under pressure, would face even more.

One source familiar with Yahoo’s negotiations sees Microsoft’s move as an indication that it’ll be business as usual again for the companies.

“I’m not surprised” by Microsoft’s withdrawal, the source said, declining to speculate about whether it might return later with another offer. “They had their price and we had ours, and now people will just go about their business.”

Even if the Microsoft offer really is dead, it seems unlikely Yahoo can turn the clock back to January 31 and hope we’ll all forget about that pesky Microsoft distraction. Shareholders, for one, got a taste of Yahoo stock at a much higher level than the search company had been able to reach on its own.

Through its ad partnership test with Google Yahoo has shown it’s willing to take drastic measures to turn its business around. Even without Microsoft around to pump up the stock price, the company has raised expectations for better performance.