Microsoft nears hostile bid for Yahoo

Until recently, the idea that Microsoft would even consider a hostile takeover bid for one of Silicon Valley's leading companies would have seemed unthinkable.

But with only three weeks to go until a critical deadline in its manoeuvring for control of Yahoo, that is exactly the step the software giant has positioned itself for.

Conventional wisdom in the Valley has long held that even friendly takeovers are a deeply risky move, since top engineering and management talent is often lost. Hostile bids are seen as a scorched earth tactic better left to old-line industries that have run out of more constructive ways to create value for their shareholders.

From the start, Microsoft issued a veiled threat that it would "pursue all necessary steps" to press its bid. With Yahoo's board still weighing its options, that has led in recent days to signs of more direct sabre-rattling.

To force through its offer, Microsoft is now preparing to submit its own directors for approval at the next Yahoo shareholder meeting. It has until March 13 to trigger that proxy fight, with Yahoo's shareholder meeting normally held in June.

The software company is also considering launching an exchange offer directly to Yahoo's shareholders, inviting them to accept its cash and stock bid, although the internet company's poison pill would stop Microsoft gaining control without board-level support.

Sending a message about its intentions at this stage looks like a heavy reminder to Yahoo that time is running out. A company that is prepared to publicise an unsolicited offer carrying a big premium, as Microsoft did on February 1, has already signalled that it is willing to follow through to a full hostile proxy battle, according to Morton Pierce, a merger and acquisitions specialist at Dewey & LeBoeuf. "It's like a chess game - I assume they thought through this step and assumed they'd be rebuffed initially," he said.

If Microsoft is forced to launch an all-out war, it can at least draw some comfort from Oracle's acquisition of software rival PeopleSoft in the Valley's most heated hostile takeover.

"The textbook had always said not to try a hostile if you're in any way worried about the impact on people and products," said one investment banker based in Silicon Valley. "But Oracle changed the mindset. PeopleSoft held up very well for more than a year while it was under attack."

But one difference in that case was that Oracle had little need for either PeopleSoft's senior management team or its rank-and-file engineers, and based its acquisition on substantial job reductions.

In an interview with the FT at the weekend, Bill Gates, Microsoft chairman, repeated that the company saw Yahoo's engineers as an asset. However, he also indicated that Microsoft believed it had the technical resources to go it alone in the search business.

Other executives say that in some critical areas of technology, such as its search advertising system, Microsoft is ahead of Yahoo, suggesting that it would see little need for Yahoo's overlapping technology.

As one Silicon Valley investor said: "A hostile takeover indicates that the value in the less volatile parts of the business, like brand name, installed base, customers and infrastructure, is more valuable than the volatile parts of the business, like engineers and executive talent."

That would be a bitter message for Yahoo employees and one reason the company has promised severance packages in the event that any takeover leads to lay-offs.

In spite of the preparations for war, most analysts still believe that Microsoft is hoping to press Yahoo into submission before it has to take that step.

At least on the surface, a higher offer is not part of that campaign, with Microsoft executives in recent days reiterating that their offer is "full and fair". But with Yahoo's shares trading slightly above the offer price, Wall Street expects that Microsoft will eventually sweeten its bid.

"Generally, a proxy contest leads to the [target company] agreeing a deal," said Mr Pierce. "At some point, Yahoo would give in." That is an assumption that Microsoft may soon have to put to the test.

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