Does Microsoft really 'undervalue' Yahoo?

In a new round of public letters, Microsoft CEO Steve Ballmer and Yahoo CEO Jerry Yang tussled about whether the software power is offering too much or too little for the Internet company. So who's right?

There's no simple answer here. It's tricky math, especially given overall declines in Internet stocks and the fact that Yahoo's worth is different depending on whether you consider it a standalone company or a part of Microsoft, which said it expects "at least $1 billion in annual synergy" from an acquisition.

But we surveyed a number of analysts--call it the wisdom of the equity analyst crowd. Opinions varied, but we didn't run into anyone who thought Yahoo could expect a dramatically higher price.

For background, Ballmer threatened Saturday that if a friendly deal isn't wrapped up within three weeks, the company will launch a proxy contest to try to elect its own board of directors. And if it goes that route, Yahoo should expect a lower offer, he said.

Microsoft CEO Steve Ballmer

"The substantial premium reflected in our initial proposal anticipated a friendly transaction with you. 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," Ballmer said in his letter to Yahoo.

Yang and Yahoo Chairman Roy Bostock responded Monday that Microsoft's offer is too low, though: "Our position is simply that any transaction must be at a value that fully reflects the value of Yahoo, including any strategic benefits to Microsoft, and on terms that provide certainty to our stockholders."

Microsoft announced its desire to acquire Yahoo in February, in what would have been a cash-and-stock deal that amounted to $31 a share.

Yahoo's shares have increased significantly since the deal was announced, from $19.18 beforehand to $27.70 Monday. Microsoft's have dropped from $32.60 before the proposal was announced to a close of $29.16 on Monday; Yang and Bostock observed, "The value of your proposal today is significantly lower than it was when you made your initial proposal."

Jerry Yang, Yahoo's CEO

Analysts vary in their opinions about the price, with some calling $31 per share a fair deal and others expecting Microsoft to sweeten the deal.

"We think reaching a mutual agreement would be the best way for Yahoo to potentially extract a higher bid," UBS analyst Benjamin Schachter said in a report. And Microsoft might well be willing, he added. "We believe Microsoft's negotiation tactics are very similar to Oracle's in its quest to acquire PeopleSoft, and as such believe a slightly higher bid could still be in the cards."

Oracle's 18-month effort to acquire PeopleSoft began on a very acrimonious note when compared with the Microsoft-Yahoo deal, but ultimately Oracle's acquisition settled after its price rose sufficiently high. Oracle's opening offer of $16 per share was significantly less than the eventual price of $26.50 per share.

Referring to Microsoft's three-week deadline, Schachter said, "We think Yahoo has no choice but to enter into a deal within this time frame, as there are no other viable suitors in our view."

And Yahoo's position is losing strength because of declines overall in its category of companies, Steve Weinstein of Pacific Crest Securities said in an interview.

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"When Microsoft made its bid for Yahoo, the share price was around $20," Weinstein said. With Yahoo's category declining overall, "it's a difficult argument to make that Microsoft's offer is unfair."

Derek Brown of Cantor Fitzgerald already sees $31 per share as a good deal. "When the deal was originally announced, we maintained a hold rating but raised the price target to $31 per share, believing that was a very healthy premium to where Yahoo had been trading and given what appeared to be deteriorating fundamentals in Yahoo's business," Brown said.

Brown said he doesn't know what Yahoo's "full value" is, though. "It would be interesting to see the measurements or comparables they (Yahoo) are using to determine that."

Mark Mahaney, a financial analyst at Smith Barney Citigroup, also said it's hard to value Yahoo definitively, or even whether to assess its value as a standalone company or as a part of Microsoft. But it's possible to estimate value based on financial results of other companies that recently have been sold--Aquantive, Digitas, and 24/7 Media, with Microsoft itself buying the first.

"There's a reasonable valuation support base for Yahoo being sold at between $31 and $34 (per share) by looking at what other Internet advertising companies have been bought for," Mahaney said.

Scott Kessler, equity analyst at Standard and Poor's, called $31 "a pretty fair valuation," based on how Yahoo's stock price compares to its earnings. "The reality is this is a difficult situation for Yahoo. Clearly Yahoo has had its share of difficulties over the last several quarters."