By Allan Sloan
Tuesday, February 5, 2008
Most of the talk about Microsoft's hostile offer for Yahoo has focused on whether the deal could tip the scales in the battle for Internet dominance. Today, I'd like to steer the conversation to something a little more basic that almost everyone has overlooked: the numbers.
To give us some perspective, I went to Joe Rosenberg, one of Wall Street's biggest hitters, to get his take on the deal. Simply put, he thinks Microsoft's offer is nuts. "This is like a person who's completely lost his mind," Rosenberg told me. "It's absurd. They're not going to earn anything like a reasonable rate of return on their investment in Yahoo. It just doesn't make sense."
Rosenberg's opinion matters. As chief investment strategist of the Loews conglomerate, which owns a piece of Microsoft, he is one of the most influential voices in the financial world. His criticism of the software giant in a Barron's interview two years ago was a big factor in sparking the $40 billion buyback program that Microsoft launched in the fall of 2006.
Before we continue, a disclosure: Loews is one of my biggest individual holdings, which means I have money riding on Rosenberg's investment acumen. Now back to the main event.
Rosenberg's biggest beef with the deal is that it would hurt the value of Microsoft shares. "This deal would do more harm to Microsoft shareholders than any of its competitors can do to it," Rosenberg said. "The company has lost sight of its principal focus, which is to produce value for shareholders."
Until the Yahoo bid surfaced, Rosenberg was predicting that Microsoft would earn almost $2 a share in its current fiscal year, rising steadily to more than $4 a share in four years. (In his view, Microsoft's sales to "developing markets" such as China, India and Eastern Europe will soar.) So at $32 a share -- its price before news of the Yahoo offer drove its stock down sharply Friday -- Microsoft looked cheap to Rosenberg. Now, he fears, Microsoft may be making the same mistake as two other companies that did large but ultimately unsuccessful high-tech takeovers.
No, he's not talking about the 2000 deal that combined America Online with my employer Time Warner, which many people have cited as a cautionary tale for Microsoft-Yahoo. In Rosenberg's opinion (and mine) that transaction is not a good comparison. Why? Because America Online's purchase of Time Warner turned out great for AOL shareholders, whose stock fell far less than other Internet issues when the bubble popped. The deal was disastrous for the sellers -- the old Time Warner stockholders -- who had the value of their shares eviscerated.
The real parallels to Microsoft-Yahoo, says Rosenberg, citing his 47 years on Wall Street, are two largely forgotten disasters: Xerox's $1 billion purchase of Scientific Data Systems in 1969 and AT&T's $7.5 billion purchase of NCR in 1991. In both cases, the acquiring company paid top dollar for a firm whose products and technology rapidly became obsolete.
Rosenberg doesn't pretend to be a tech maven, but he says it's clear that the market -- which sent Yahoo's stock down 45 percent from October through last Thursday -- is saying something negative about Yahoo's businesses and prospects. Microsoft, Rosenberg says, would be well-advised to listen.
Should Microsoft buy Yahoo, Rosenberg says, he, like other folks looking at this deal, expects Microsoft and Google to engage in price wars in the search and advertising businesses. But Rosenberg takes those expectations one more step: Such a price war would hurt Yahoo's already anemic profit margins, he says, making a Microsoft purchase even more problematic. Microsoft's future free cash flow per share would be substantially higher if it buys back its own shares, he said, rather than buying Yahoo by issuing about $23 billion of new stock and spending a net $14 billion or so in cash. (That cash number takes into account the approximately $8 billion of cash and marketable securities that Yahoo owns.)
Rosenberg says he's not trying to hurt Microsoft; he's trying to help. "They don't realize that by criticizing this deal, I'm trying to do them a favor," he says. And, of course, to do Loews a favor, too.Off-Track Stimulus
Now here's a look at another proposal that has left me scratching my head. The economic stimulus package slogging its way through Congress includes a measure that would expand by 75 percent the maximum size of the home mortgages that Fannie Mae and Freddie Mac can buy, to just under $730,000 from the current $417,000.
Foolish me. The conventional wisdom is that stimulus is supposed to be "timely, targeted and temporary." But, by that measure, unleashing Fannie and Freddie would go, at most, 1 for 3. That's because even though it may be timely, it's targeted at people like me with expensive homes who don't particularly need help. And even though the loan limit is supposed to revert to $417,000 next year, that's unlikely to happen, given the realities of Washington and those companies' political clout.
If we're going to unleash Fannie and Freddie, which are so big that serious problems at either could threaten the financial system, we should at least strengthen regulation of them. Alas, stronger regulation isn't part of the fast-track stimulus legislation.
The stimulus package would add "significant new responsibility to these companies at a time when they're really stressed," says Jim Lockhart, director of the Office of Federal Housing Enterprise Oversight, which regulates Fannie and Freddie. "Without stronger, bank-like powers for the regulator, this could lead to serious problems." A statement with which, I think, any reasonable person has no choice but to agree.
Allan Sloan is Fortune magazine's senior editor at large. His e-mail address email@example.com.