Microsoft gives Yahoo a deadline, threatens hostile takeover

Microsoft Chief Executive Steve Ballmer issued an ultimatum to Yahoo's board of directors on Saturday morning: Agree to our "generous" acquisition proposal within three weeks or we're launching a hostile takeover.

Representatives from the two companies have met informally but have made no progress toward an agreement since Microsoft offered $31 a share for the Internet giant two months ago. The offer, which worked out to $44.6 billion, 62 percent more than Yahoo was worth at the time, initiated what could be the largest acquisition in the history of the technology industry.

Since then, Ballmer asserted, Microsoft's offer has become more generous in the context of a weakening economy, changes in Yahoo's business and its inability to attract a counteroffer from other would-be suitors.

"By any fair measure, the large premium we offered in January is even more significant today," Ballmer wrote in a letter made public by Microsoft.

As Internet search and advertising leader Google grows stronger, both Microsoft and Yahoo, led by co-founder and CEO Jerry Yang, are falling behind. Microsoft has committed itself to becoming a major player in online services and advertising. It sees the acquisition of Yahoo as the fastest way to gain millions of users, some of the most-visited sites on the Internet and an influx of engineering talent needed to become a more powerful challenger to Google's dominance.

But clearly, Ballmer's patience with Yahoo's board — which formally rejected the offer in early February, saying it "substantially undervalues" the company — is wearing thin.

"If we have not concluded an agreement within the next three weeks, we will be compelled to take our case directly to your shareholders, including the initiation of a proxy contest to elect an alternative slate of directors for the Yahoo! board," Ballmer wrote.

With those words, Ballmer gave notice that Microsoft is preparing a hostile takeover, a possibility the company has mentioned since the acquisition was first proposed publicly Feb. 1.

Yahoo had no immediate response Saturday.

"Microsoft has to do something to bring this to a close," said Tim Bajarin, president of Creative Strategies, a Silicon Valley industry analyst. "Anytime that you have this kind of open-air negotiation between two companies and there's no clarity, they both suffer."

Ballmer's threat to take the case directly to shareholders signals an exchange offer in which Microsoft would trade a combination of cash and its stock to Yahoo shareholders for their shares of Yahoo, in an attempt to gain a controlling interest in the Sunnyvale, Calif.-based company.

Because Microsoft's offer is a blend of cash and stock, its actual value floats with Microsoft shares, which have declined since the acquisition proposal was announced. As of Friday's closing price, the bid for Yahoo was worth $42.2 billion.

In combination with the exchange offer, Microsoft would likely launch a proxy contest, in which it would try to persuade Yahoo's shareholders to elect directors amenable to the takeover proposal at its next annual meeting, which has not been scheduled. It was held last year on June 12.

Both tactics can result in a lower price for the acquired company — a specter Ballmer raised in an attempt to further pressure Yahoo's board to come to the negotiating table.

"The substantial premium reflected in our initial proposal anticipated a friendly transaction with you," he wrote. "If we are forced to take an offer directly to your shareholders, that action will have an undesirable impact on the value of your company from our perspective which will be reflected in the terms of our proposal."

Analysts viewed Ballmer's letter as an important turning point.

"This letter is going to hit [Yahoo's] stock on Monday and it will certainly at least make shareholders tell the Yahoo board, 'You have to at least be talking to them,' " said Matt Rosoff, an analyst with Kirkland-based Directions on Microsoft.

But Ballmer's April 26 deadline gives Yahoo time to wait for its first-quarter financial report, scheduled for April 22. The company was optimistic about its near-term and long-term prospects, which it detailed in an investor presentation last month.

If Yahoo shows improvement, it could bolster the board's case for rejecting Microsoft or at least holding out for a higher purchase price.

Many major Yahoo shareholders have favored an acquisition, while hoping for a higher price — which Microsoft is unwilling to offer, according to sources close to the company quoted last week in The Wall Street Journal. Shareholders and analysts have been skeptical of Yahoo's ability to meet its ambitious goals.

Ballmer is, too. In fact, Microsoft believes Yahoo's business is deteriorating.

"During these two months of inactivity, the Internet has continued to march on, while the public equity markets and overall economic conditions have weakened considerably, both in general and for other Internet-focused companies in particular," he wrote. "At the same time, public indicators suggest that Yahoo!'s search and page view shares have declined."

Google has only grown stronger in the interim. Its share of U.S. Internet searches grew in February and it completed its acquisition of online ad service company DoubleClick in March, giving it an even stronger position in the battle for an online advertising market worth $40 billion and poised to grow.

And therein lies the threat to Microsoft.

"If Microsoft continues to let Google grow unchecked, eventually Google could have a monopoly position in search and online advertising," said Rosoff, the Kirkland analyst. "Google could use revenue from that to fund attacks on Microsoft's core businesses."

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com