Buzz Analytics: Profiting from MSFT / YHOO Alliance
By Jason Hines on October 26, 2009
In February 2008, Microsoft (MSFT) offered to buy Yahoo! (YHOO), with the intention of creating scale in the search business to compete against Google (GOOG). Despite a sweetening of the offer to $33 per share in May, Yahoo! rejected the overture, leaving Microsoft CEO Ballmer to admonish in a letter to Yahoo! CEO Yang:
We will move forward and will continue to innovate and grow our business at Microsoft with the talented team we have in place and potentially through strategic transactions with other business partners.
I still believe even today that our offer remains the only alternative put forward that provides your stockholders full and fair value for their shares. By failing to reach an agreement with us, you and your stockholders have left significant value on the table.
Fast forward a year and a half, and Ballmer and Yahoo!’s new CEO, Carol Bartz finally closed a deal in July, 2009, with the market’s reaction, a $3 billion hit to YHOO’s market value (12%), suggesting that Ballmer was right: the deal was worth significantly less to YHOO than anticipated by investors.
[Unless otherwise noted, all stock price reactions refer to YHOO. At roughly 10x the market capitalization, the impact on MSFT is relatively muted and difficult to capitalize on.]
We hypothesize that there might be some way to profit by anticipating the events from exploring Recorded Future’s momentum indicator of Microsoft and Yahoo! interactions. Looking at the timing of our signals from an ex ante (i.e., in advance) perspective, we correctly identified a two week window for an announcement. For someone with perspective on the deal, there was money to be made. [in particular that there was not going to be an upfront payment to YHOO, while Yahoo’s market value fell by $3 billion, Microsoft’s market value increased by $3 billion. This $3 billion shift in market value was roughly the high end of estimates for the upfront payment.]
A Microsoft / Yahoo! deal was on investor’s minds, following a failed MSFT bid last year, and the collapse of a YHOO / GOOG deal in November. On January 13, Yahoo! announced the appointment of a new CEO, Carol Bartz. That day, of 276 mentions about YHOO, and 135 mentions of MSFT, 28 included specific deal-related terms. With the market believing that there was now less resistance, a deal would be more likely, leading to a 3% gain in the stock (YHOO).
However, with reports that Bartz told employees that her instinct was to keep the search business, the stock fell 6% on Thursday as the market concluded that a deal was actually less likely. This latter point was major news, leading many of the articles that identified a specific relationship between the companies, with the stock drop suggesting that investors were anticipating the deal. Articles mentioning MSFT increased about 50% from the previous day, with specific deal-identified expectations accounting for about ½ the incremental mentions. Over the 4-day period following, about ¼ of the total articles with MSFT included a specific YHOO deal, while about 1/5 of the YHOO mentions included a specific MSFT deal. Looking forward, we use these numbers to establish a threshold for specific review: 28 identifiable events (defined as business relation, alliance, merger, acquisition, or joint venture).
Specific deal mentions as a driver of total mentions of MSFT and YHOO
April 10, 2009
Recorded Future finds 58 MSFT + YHOO deal events, nearly ½ of all the articles mentioning either company, with news breaking that Bartz and Ballmer are talking. With a total of 97 over the weekend through Monday, YHOO closes up 7% vs. a flat tech-index and a down MSFT. (The market was closed on Friday.) This was a much larger number than we saw back in January. Clearly people are more excited, and the deal premium is increasing. But it isn’t clear when, or exactly what, might happen, [with the relevant question likely being the relative changes in negotiating power between the parties. A lot of deals have been restruck, and not clear that shouldn’t happen here as well.]
Seeing a moderate peak in defined events, 29 over two days so technically below our threshold, on comments from Bartz about “boatloads of money” needed for a deal. With “biiiiig boatloads of money” needed for the whole company, one would have to ask if any upcoming deal would be smaller than previously offered.
June 3, 2009
Seeing 48 defined events, on comments from Ballmer and Bartz at an investor conference. For quick context, YHOO has outperformed by 5% since Bartz’s comments on 5/27. Now, she says that YHOO would save $500-700 mm in annual cash flow, so upwards of 30% after-tax cash flow. This is material. But she also said: “Forget about the Microsoft stuff, it’s honestly not that relevant.”, and that it might make more sense for MSFT to sell its internet operations to YHOO.
She is certainly posturing, but the savings from a deal is strong driver for a deal. The question remains what it will look like, as there is a significant deal premium built in, though much less than initially proposed last year. That means a large risk either way. Looking at the chart, two peaks are starting to come closer together, about 2 months apart (with intermediate peaks) instead of the previous 3 month interval. Then again, this is only a single datum point. Together with the increasing specifics, this suggests a potentially closer event.
June 24, 2009
We have 39 hits around the YHOO shareholder meeting. Not as large as the previous peak, but still above our threshold. Considering that Bartz’ comment was, we’ll let you know when something happens, a lot of people found it significant. Yahoo!’s stock jumps 5% during the day. From the technical side, we do have an interesting confirmation of the increasing frequency of large signals, with only 3 weeks between the last signal and this one. The last 4 events were separated by 3 months, 2 months, now <1 month. At the very least, it would seem that we are getting close to something.
July 17, 2009
Momentum just went through the roof to 75 (a new high) as YHOO stock is up 4%, with rumors of the deal happening in the next week. Including the weekend, we have 137 hits, with about 60% of all Yahoo! mentions including an explicit deal link to MSFT. This signal is 3 weeks after our most recent peak, which reinforces the observation about increasing frequency (we’re now at 3 months, 2 months, 3 weeks, 3 weeks).
We are also seeing more specificity with respect to timing and terms, which would suggest greater clarity and higher probability. So the next signal should be within 3 weeks, except that next week we have earnings from both companies; nothing will happen before then, but soon thereafter? Call it somewhere between July 27 and August 7.
July 28, 2009
We’re seeing a new spike in joint mentions, only 11 days since the last peak, and 2 post-earnings trading days, we get a new peak with 78 hits. The signals are probably as close together as they can get, which means that we should see our event any day.
July 29, 2009
In the morning, the deal is announced. YHOO stock takes a dive, while MSFT rises by a roughly similar market value, as the deal does not include the expected upfront payment from MSFT. We were spot on about the timing. The value to the investor here was establishing the details of the deal, which were disappointing. Clearly, the negotiating dynamics had changed, perhaps along the lines anticipated by Ballmer’s letter, though there were other signs as well.
At the very least, it seemed like any deal would be smaller in scope, for search, not the entire company. However, we also had a major head-fake in the oft-mentioned ‘boatloads of money’ for putting together a deal, and Ballmer was aggressively courting Bartz, so an upfront payment wasn’t out of the question.
We are in the process of building additional/refined momentum indicators. It will be interesting to see how it will add to our forecasts.