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Wooing Yahoo

Those with a long memory might recall that Rupert Murdoch was one of the early internet evangelists.

In 1993, he acquired the internet service provider, Delphi, and entered a joint venture with the American telecom firm MCI. The plan was to launch a service called iGuide that would combine internet access, a daily online newspaper and a guide to the web as well as content from parts of the News Corporation empire. But MCI pulled out at the last minute and Murdoch lost his nerve.

In the decade that followed, the tycoon held back from large-scale investments online, to the derision of rivals during the boom years, and then to his own smug satisfaction when the deals hatched by other media conglomerates turned sour.

Sense of urgency

But by 2005, the march of advertising dollars online was undeniable, and Murdoch began to prowl cyberspace again. That year, he paid $650m for IGN Entertainment, which runs sites such as GameSpy.com for video game fans, and, more significantly, $580m for Intermix Media, a company that owned 30 internet properties including the social networking site MySpace. The MySpace deal, which anticipated the huge growth in social networking online, looks with hindsight to have been an extremely clever move.

Now Murdoch appears ready to take the next step. It emerged in the middle of last week that News Corp is in discussions to merge MySpace and other News Corp internet properties with Yahoo, in return for a 20% stake in the combined company. News Corp had held similar, fruitless, discussions with Yahoo last year, but Yahoo boss Jerry Yang is feeling a new sense of urgency.

At around the same time as Murdoch was investing in Delphi, Bill Gates was penning a memo to senior executives at Microsoft called ‘The Internet Tidal Wave’, in which he said the nascent medium had become his number one priority. Like Murdoch, he arguably failed to deliver on that early belief over the decade that followed. In the tussle for Yahoo, News Corp and Microsoft are fighting to go back to the future.

It is more than two weeks since Microsoft stunned the industry with its near $45bn offer for Yahoo. Fighting for independence, Yang has spent the time since working on an escape route. He is also said to have held exploratory talks with AOL and sounded out a deal that would outsource Yahoo’s search business to Google. But the deal with News Corp appears to hold the fewest obstacles of any of the alternatives to Microsoft.

Murdoch had made it clear just a week earlier that he would not bid for Yahoo in its entirety, but in a typical piece of agile opportunism he has revived his earlier plans while Yahoo is at its most vulnerable. Yang and Murdoch are said to have met recently over dinner. A deal would also be likely to involve a cash injection from a private equity backer. Murdoch is said to feel he has ‘nothing to lose’ by getting into discussions even though the chances of success are held to be remote.

For Murdoch, Yahoo would provide an online audience of some 500 million people for both his online properties like MySpace and for content from other parts of the sprawling News Corp empire. ‘I am sure Murdoch is serious about this because he wouldn’t waste the time,’ says one industry insider. ‘You can see that Yahoo would fit very well with a social network like MySpace - the combination could be quite powerful.’ Other News Corp properties that could be part of the deal and benefit from the eyeballs on Yahoo include film fan site Rotten Tomatoes and photo-sharing site Photobucket.

Yahoo formally rebuffed Microsoft’s bid last Monday, using familiar dance moves; it said the offer ‘substantially undervalues’ Yahoo, failing to recognise the strength of its brand, the size of its audience or its growth potential. The rejection places Microsoft in unfamiliar territory. Although it has done a series of takeovers in the past, all have been agreed, and none were anywhere near this scale.

But Microsoft seems to be in determined mood. The firm has already begun to sound out Yahoo shareholders and there are signs of encouragement. Legg Mason (Investments), the second largest shareholder in Yahoo, said last week that it looked favourably on the Microsoft deal, albeit at a higher price.

On Wall Street, analysts are viewing a potential transaction with Murdoch as an interesting distraction, but most still believe that Microsoft will win the day. ‘It is vital to Microsoft’s online strategy,’ says Jeffrey Lindsay, at Sanford Bernstein in New York. ‘They have been trying for about five years to establish a good online strategy and haven’t really got anywhere; this would be a shot for them to catch up to Google a bit. If they had to go back to square one and start building up MSN, it would be a tough road. I think they are prepared to do whatever it takes to achieve this.’

Figures compiled by eMarketer show that Microsoft’s MSN web portal has been steadily losing advertising share, falling from 7.3% five years ago to 5.2%. Google has gone from 10.1% to 40.4% in the same period. Yahoo has 15% of the portal advertising market and AOL 5.5%.

Yang resumed control of Yahoo as part of a management shake-up in June. Just ahead of the Microsoft bid, Yahoo had posted a 24% drop in fourth quarter profits to $205m and announced plans to cut 1,000 jobs. Yang had asked for patience and predicted a turnaround, but not before 2009.

Yahoo investors, who have watched the value of their shares decline to four-year lows, don’t seem inclined to wait. Of all the options on the table, they look likely to prefer the certainty of a deal with Microsoft as well as some upfront cash. An agreement with Microsoft would merge two similar businesses, allow them to strip out significant costs and pool technologies. An agreement between News Corp and Yahoo offers less surety, especially given that MySpace has so far disappointed in delivering advertising revenue. ‘Combining MySpace and Yahoo probably wouldn’t have anything like the cost savings of combining MSN and Yahoo,’ says a source. ‘Also Murdoch is not putting up $45bn. It is a very different strategy and one that he would need to persuade Yahoo shareholders was worth doing, because they would not be getting the financial orgasm from the Microsoft deal.’

If nothing else, Murdoch has lost none of his ability to surprise; setting his pugnacious jaw against the world, just as he did most recently in his tussle for the Wall Street Journal. It was a disagreement on the valuation of MySpace that had been the sticking point in Murdoch’s previous negotiations with Yahoo. ‘I think it is a very shrewd move for Murdoch,’ says Lindsay. ‘The transaction would value MySpace at $10bn, for the sake of argument. The large uncertainty for News Corp is what the true value of MySpace is, and so a deal like this is attractive because it pegs a particular value on the asset.’ Murdoch has also managed to talk up the valuation of MySpace to almost 20 times the amount he paid for it less than three years ago.