Entries from February 2008 ↓

I do not wish to diminish the importance of the steroid scandals that repeatedly rock pro sports.  It’s a problem.  True sportsmen recognize their abilities, their limitations, and the efforts of other players who are less able.  Professional athletes are role models, and they have a duty to the kids to look up  to them.  But doesn’t Congress have something more important to do than investigate doping in baseball?

I was happy to see the Wall Street Journal article reporting that Yahoo!’s board plans to reject Microsoft’s offer. Also, the optimist in me hopes that they can continue to stave off Microsoft because of the poison pill adopted in March of 2001. The press has made a lot of allusions to the poison pill, but nobody has really explained how it works. I am not a securities lawyer, but I decided to try to interpret the SEC filing and the corresponding rights agreement and translate them into plain English. Here is my understanding (any securities lawyers out there who want to correct me, please do so!):

If you own common stock in Yahoo!, you have the right to buy preferred shares at the price of $250,000 per share for each thousand shares of Yahoo! common stock you hold. This is a pretty useless right, because preferred stock has no voting privileges, and although preferred stock is entitled to dividends before common stock is, Yahoo! has never paid a dividend, so preferred stock in Yahoo! has no value.

But, your right to buy those preferred shares includes a little magic spell: If a person or company tries to acquire Yahoo!, then once that “Acquiring Person” holds 15% of Yahoo!’s stock, you magically have the right to buy common stock at 50% of its current market price. But the Acquiring Person (or company) does not have that right. Why does this matter? If Yahoo!’s board refuses to sell the company to Microsoft, but Microsoft really, really wants to own Yahoo!, Microsoft could try a hostile takeover of Yahoo! by purchasing Yahoo! stock on the open market, with the ultimate goal of controlling more than 50% of Yahoo! stock. This is not exactly as straightforward as it sounds, but it’s still very doable.

So what happens in this scenario? As Microsoft is buying up Yahoo! stock, at some point they will cross the 15% ownership threshold, and when that happens, the other 85% of Yahoo!’s stock will, in effect, undergo a 2-for-1 split. The price of your Yahoo! stock will drop by about 42% (or maybe less), but you will be happy about this because you will suddenly have twice as many shares as you did before. Your investment in Yahoo! will go up in value by about 16% (or maybe more). Microsoft’s 15% stake in the company will be transformed into a 7.5% stake, and Microsoft will have to lay out more cash than it originally intended if it wants to go ahead with the acquisition.

Now, don’t get too excited if you are a Yahoo! shareholder — this windfall is not entirely guaranteed. Yahoo!’s board can cancel the poison pill if they receive an offer that they think is fairly valued, but for now it looks like they will require a lot more than $31 per share before they do that. At least Yahoo!’s board understands the value of what they have. Now all they need to do is stave off Microsoft and fix Yahoo! to unlock all of that value hidden under their bureaucracy.

It’s almost two years since I have written a blog, but in the last few days several people have asked my opinion of Microsoft’s bid to buy Yahoo!, so it seemed like a good time to start writing again.

I worked at Yahoo! from March of 2003, after they acquired Inktomi, until July 2007, when I left to attend business school in New York. During my four-plus years at Yahoo!, I worked in several capacities from engineering on the search engine to product management for various search products such as search submit, then core web search, and later Yahoo! Answers. As we struggled to compete with Google, I tried to figure out what was holding Yahoo! back.

I believe that all of Yahoo!’s major problems stem from two points:

1. Identity crisis — Is Yahoo! a media company or a technology company? A content producer or a search platform? Management never gave clear direction on either of these questions, so lower-level employees were left without the basic guidelines they needed to make good decisions.
2. Bureaucracy and a culture of risk aversion — Yahoo! isn’t slow to ship products because of a lack of creativity or a lack of technical talent. New, creative, powerful prototypes are built all the time, but many never see the light of day. Yahoo!’s culture had developed in a bizarre fashion, whereby any manager at any level had enough veto power to grind projects to a halt, and almost nobody actually had the authority to push a project forward. This meant that even the smallest change required weeks or months of internal politicking and persuasion with dozens of people, each looking at the project through a different lens and trying to expand its scope to achieve an additional goal. I remember a seemingly small project that listed over thiry people on its team when it launched.

Making Yahoo! part of a larger, more diversified company will not solve either of these problems. These problems can only be solved by focus and a radical shakeup of middle management, such as the one proposed in late 2006.

Compounding these organizational challenges are technical issues that would stifle new product development for at least a year. It is reasonable to assume that Microsoft would pressure a newly-acquired Yahoo! to port its existing infrastructure from BSD and Linux to Windows-based servers. This would be a herculean effort with no gain save its marketing value, and it would likely result in embarrassing outages, just like the last time Microsoft tried to do something similar.

So who can fix Yahoo!, if not Microsoft? I think the company needs an outsider CEO who can come with a fresh point of view and make hard decisions about where to invest and where to cut, define a single vision, cut the bureaucracy, and instill a culture that encourages risk-taking. This will mean volatility and uncertainty in the short term, but it is the only viable answer. Yahoo! has favored stability over risk for the last several years, and its reward has been a predictable, consistent decline in market share, brand equity, and revenue. From here it can bleed to death alone, bleed to death as part of Microsoft, or face uncertainty and try to capitalize on its last chance to be a disruptor. I suspect that Yahoo!’s board knows all of this, which is why they are frantically searching for other options. If they succeed in staving off Microsoft, and they install new management that actually takes radical action, there is no reason they can’t make Yahoo! into 50, 60, or 70 billion dollar company.