The Wall Street Journal-20080202-Microsoft-s Bid for Yahoo- Hostile Deals- It Turns Out- Are Sign of Web-s Maturity

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Microsoft's Bid for Yahoo: Hostile Deals, It Turns Out, Are Sign of Web's Maturity

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There will be blood.

Microsoft Corp.'s unsolicited $44.6 billion offer for Yahoo Inc. is not only the second-largest prospective tech deal on record, but a cultural milestone for an industry that long regarded itself as playing by different rules than the rest of the corporate ecosystem.

For the commercial Web's nearly 15-year history, hostile deals have been taboo. That's largely because companies were focused on new growth rather than cost savings. Inside the tight-knit world of West Coast engineers and venture capitalists, the "hostile" was regarded as a dangerous approach for losing creative talent.

No more. Incumbent players are showing wrinkles, as growth levels off and costs mount. As one Wall Street hand put it on Friday: Microsoft's offer for Yahoo is more akin to a utility merger than a tech deal.

"Would a start-up launch a hostile? No. But Microsoft is so far beyond that that they've become institutionalized, and are a much more traditional corporation," says one veteran deal attorney.

Oracle Corp. founder Larry Ellison has embraced the concept, going after a string of companies. "There's this bizarre notion in the computer industry that we'll never be a mature industry," Mr. Ellison told The Wall Street Journal in 2003.

Indeed, Microsoft's pitch to investors was keyed to cost savings, or "synergies and scale" in merger speak. Combining the two companies' search operations and sharing the cost of research and development would save at least $1 billion, according to Microsoft. By comparison, that is roughly the size of Yahoo's entire research-and-development budget.

Yet in tearing up the old rule book, Microsoft is wandering into deeply strange territory. The offer is the biggest unsolicited approach in the U.S. since Comcast Corp.'s unsuccessful $55 billion offer for Walt Disney Co. Only two unsolicited deals of greater size have succeeded in the past decade -- Pfizer Inc.'s $110 billion takeover of Warner Lambert Co., and Vodafone Group PLC's purchase of Airtouch Communications Inc., both in 1999, according to data from Dealogic.

A hostile bid can sour the atmosphere between two companies and often alienates employees. And though shareholders sometimes fare better in hostile deals, companies often emerge weakened. Hostile bids can also set off an auction in which the initial bidder is regarded as the least attractive suitor.

On that score at least, Microsoft should rest relatively easy. It would be very difficult for most strategic buyers to compete with its financial firepower. And with credit markets in turmoil, private- equity firms aren't likely to raise the kind of financing they'd need to fund a rival bid.

That doesn't mean Yahoo won't go down without a fight. The company has a "poison pill" in place to fend off hostile bids, which would make it prohibitively expensive to buy up shares in the open market. Under the plan, according to FactSet Research Systems Inc., Yahoo could issue discounted shares to existing holders, a move that would substantially increase the cost of a takeover.

But the timing of Microsoft's offer suggests it would be willing to take its case to shareholders via a proxy fight for Yahoo board seats. Microsoft has until March 13 to nominate a slate of directors to Yahoo's board. If shareholders approved the nominees, they could then drop the poison pill and clear the way for the acquisition. But many observers doubt Yahoo's board will pursue that route, especially if Microsoft agrees to increase the offer price.

The deal's size underscores how the Internet sector is maturing. If successful, the deal would count as the largest-ever pure technology tie-up, nearly two times as big as Lucent Technologies' $23.9 billion purchase of Ascend Communications Inc. in 1999, and eclipsing Hewlett- Packard Co.'s $19 billion acquisition of Compaq Computer Corp. in 2002, says Dealogic.

When H-P launched its acquisition of Compaq in 2001, the deal was widely seen as a consolidation attempt amid slowing growth in the personal-computer industry, where profit margins were collapsing as PCs became more of a tech commodity.

"The H-P and Compaq deal occurred when the PC industry was certainly showing signs of maturing," says Arnie Berman, chief technology strategist at Cowen & Co. "We could make the same argument about the Internet sector today. And Microsoft is certainly a mature company, with Yahoo showing extensive signs of maturing, too."

Oracle has since popularized the technique in Silicon Valley. In June 2003, Mr. Ellison launched a $5.1 billion hostile takeover for rival software maker PeopleSoft Inc.; the attempt succeeded after a protracted fight. Mr. Ellison has since launched hostiles for other reluctant targets, including most recently BEA Systems Inc. While that hostile overture failed, the two companies last month agreed on a friendly $8.5 billion deal.