ivory press release.12.10.08

8/14/2019 Ivory Press Release.12.10.08

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Contact:Sitrick And Company, Inc.Terry Fahn(212) 573-6100Jim Bates

(310) 788-2850

FOR IMMEDIATE RELEASE

Major Yahoo Stockholder Urges Board toSalvage Microsoft Deal

Ivory Investment Management Says It Believes Yahoo Could Receive $15 Billion UpfrontFrom Microsoft and Increase EBITDA by $500 Million/Year; Says Deal Should Result in

Value of $24-$29 Per Share

Los Angeles Dec. 10, 2008 Ivory Investment Management LP, one of Yahoos largeststockholders with 21.4 million, or 1.5% of the shares outstanding, today proposed in aletter to Yahoos Board of Directors that the company salvage a deal with Microsoft andnot miss another value maximization opportunity.

Noting Microsofts renewed interest, Ivory proposed that the company sell its searchbusiness to Microsoft, with Microsoft becoming the search provider for all Yahooproperties. Under the Ivory proposal, Microsoft would own and operate the combinedsearch platform, with Yahoo becoming an affiliate that retains 80% of the revenuegenerated through searches on its own site. Finally, Microsoft would become the search

engine for Yahoos existing search affiliates.

We believe a search deal with Microsoft could deliver value to Yahoo shareholders of$24-29 per share, or more than double yesterdays closing price of $12.19.

Ivory stated in its letter that it believed Yahoo could receive more than $15 billionupfront from Microsoft for its search business and increase EBITDA by more than $500million per annum.

On an after-tax basis, the $15 billion payment from Microsoft would be $9 billion forYahoo shareholders, leaving Yahoo with $21.2 billion of cash and investments (up from

$12.2 billion today) and annual EBITDA of $2.4 billion (up from the midpoint of currentguidance of $1.9 billion). Applying a 5x EBITDA multiple on the new Yahoo wouldresult in a value of $24 per share. If Yahoo were to go a step further and deploy the $9billion in new cash for its own shares at a $16 offer price, it could reduce its share countby 40% which would leave the remaining shareholders with a stock approaching $30 pershare (amazingly close to the original bona fide bid from Microsoft).


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Noting that Yahoo and Microsoft each may be spending well over $1 billion a year ontheir respective search businesses, Ivory said that combining the two could save $800million in duplicate operating costs. In addition, due to the increased economies of scalein the search business, Ivory believes that the combination could increase total searchrevenues by at least 20% or $500 million per year.

Ivory stated that its assumptions and estimates were based on publicly available data andstatements from both companies. Even accounting for a reasonable margin of error inour estimates and assumptions, there is no question the proposed deal would significantlyincrease shareholder value (up to a 140% increase compared to the current tradingprice.)

Ivory noted that both companies need to act now because they continue losing ground toGoogle, and that it is widely acknowledged that neither company has kept pace withGoogles innovation and investment spending.

This deal would offer Microsoft the unique opportunity to immediately gain criticalmass to better level the playing field with Google, while it would simultaneously allowYahoo to both receive a sizable upfront cash payment and increase its prospective cashflow, Ivory said.

Ivory said it sent the proposal to directors to express serious concern regarding thefailure of the Board of Directors to maximize shareholder value of the company. Ivorynoted that Microsofts spurned $31-a-share offer earlier this year for all of Yahoorepresents a 150% premium to Yahoos current stock price.

The following is the text of the letter:

December 10, 2008

Board of DirectorsYahoo! Inc.701 First AvenueSunnyvale, CA 94089

To Members of the Board:

We are writing to express serious concern regarding the failure of the Board of Directors

to maximize shareholder value of the company.

We would even go so far as to argue that certain members of the Board, in repeatedlyrejecting or neglecting various attractive offers from Microsoft, may have obstructed therealization of Yahoos intrinsic value for its shareholders. As a large shareholder (wecurrently own 21.4 million shares, or 1.5% of the companys outstanding common stock),we have closely followed Yahoo over the past couple of years. We have regrettablywatched the company not only mis-execute operationally, but also mishandle, in our


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opinion, a bona fide offer from Microsoft to acquire the entire company for $31 pershare, which now represents an over 150% premium to the current stock price. In light ofMicrosoft once again publicly reaching out to explicitly express interest in entering asearch deal with Yahoo, we feel compelled to write this letter to ask the Board to takeappropriate and prompt action and not miss yet another value maximization opportunity.

We believe a search deal with Microsoft could deliver value to Yahoo shareholdersof $24-29 per share, or more than double yesterdays closing price of $12.19.

Over the last several years, the market has witnessed Google grow its search market shareand profits at the expense of both Yahoo and Microsoft. Microsoft was an affiliate ofYahoo in the search business until 2005 when each company decided to part ways in anattempt to compete with Googles search business on its own. Since then, it is widelyacknowledged that neither company has kept pace with Google's innovation andinvestment spending. As a result, both companies appear to have fallen further behind ina business area they have each repeatedly referred to as a top priority. To us, the problemis obvious its all about scale economies and critical mass. Specifically, we estimate

that Microsoft and Yahoo may each spend well over $1 billion per year on thepredominantly fixed costs of operating a search business, yet each company individuallydoes not have the proper audience scale to optimize the return on that investment. Thesolution seems equally obvious - combine the search businesses of the two companies toeliminate duplicative costs and increase revenue scale.

We envision a deal whereby Microsoft would acquire all of Yahoos search assets andenter into a perpetual agreement for Microsoft to be the search provider for all Yahooproperties. In this deal, Microsoft would own and operate the combined search platformwhile Yahoo would become an affiliate that retains 80% of the revenues generated fromthe search traffic on its own sites. In addition, Microsoft would become the searchengine for Yahoo's existing search affiliates. This deal would offer Microsoft the uniqueopportunity to immediately gain critical mass to better level the playing field withGoogle, while it would simultaneously allow Yahoo to both receive a sizable upfrontcash payment and increase its prospective cash flow (i.e., EBITDA). There are two keyreasons why we believe this proposed deal is extremely beneficial to both parties:

1) Approximately $800 million of duplicate operating costs could be eliminated.This estimate is based upon benchmarking Yahoos and Microsofts OnlineServices Business operating costs versus Googles cost structure. At theMicrosoft analyst day earlier this year, Steve Ballmer described the coststructure in their search business: I think you've got to think of it as sort ofalmost more of a fixed expenseWe won't have to be as high as Google's $2.3billion because they're serving up so many more queries, but our COGSpercentage will need to be quite a bit higher than theirs will, just to keep up inthe ante to index the largest volume of documents on the Web.; and

2) The combined search platform and marketplace would have a much greaternetwork effect, resulting in 20% higher monetization rates. Again we quoteMr. Ballmer at the Microsoft analyst day: "Wed like to increase our revenue


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per search, and the way to do that is to get more queries. The more queries weget, the more advertisers we get, the more keywords they bid on, the higher theybid, you get the virtuous cycle flowing." Furthermore, based on Yahoo's pastcomments regarding differences in monetization rates between Yahoo andGoogle, we believe our 20% monetization rate estimate is conservative. On a

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conference call this year announcing a search relationship withGoogle, Jerry Yang described the monetization differential between Yahoo andGoogle: "At the current monetization rate, we believe there is an approximate$800 million in annual revenue opportunity in the U.S. and Canada on thosequeries where monetization upside exists." This $800 million represents a 47%increase relative to the $1.7 billion of search revenue from Yahoo's total ownedproperties. However, this $800 million applies only to a subset of Yahoo'sowned properties, so the total monetization differential between Yahoo andGoogle is actually greater than 47%. Thus, we believe our assumption of a 20%improvement is less than half of the potential opportunity and could growsubstantially over time.

We believe the above factors could allow Yahoo to receive more than $15 billion upfrontfrom Microsoft for its search business and increase EBITDA by nearly $500 million perannum. Post this transaction, Yahoo would lose annual search revenues of roughly $1.7billion from its owned sites and another $450 million of revenues from affiliates (net oftraffic acquisition or TAC payments). However, offsetting this shortfall would be over$1.6 billion of annual TAC payments received from Microsoft under the new searchagreement. This payment stream assumes a TAC rate of 80% and that the combinedsearch platform can garner 20% higher monetization. Finally, we estimate that Yahoocould eliminate over $1 billion in annual costs related to search. While Yahoo does notseparately disclose the costs directly associated with its search business, sell-side analystestimates for these costs range from $700 million to $1.4 billion. In total, we believeYahoos EBITDA could increase by approximately $500 million from this transaction.The table below summarizes this conclusion:

Profit Impact to Yahoo of Proposed Search Deal(in millions)

Lost search revenues from owned sites ($1,700)

Lost search revenues from affiliates (net of TAC) (450)

Total lost revenues ($2,150)

New TAC payments from Microsoft $1,632

Savings from operating costs elimination $1,000

Annual incremental cash flow (EBITDA) toYahoo

$482

As for the benefits to Microsoft, this transaction could allow them to increase net searchrevenues by approximately $1 billion per annum, comprised of (i) $100 million ofrevenue synergies from its estimated $500 million of search revenue, (ii) over $400


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million from the retained 20% share of the new Yahoo search arrangement assuminghigher monetization rates, and (iii) $540 million of revenues from Yahoo's affiliates(120% of the $450 million that Yahoo currently earns). To earn these revenues, weassume Microsoft would have to additionally spend only 20% of Yahoo's current level ofsearch expenses, or an incremental $200 million (due to current duplicative spending).

The net effect is a pre-tax profit increase of over $800 million per year for Microsoft.Microsoft has tremendous cash resources (over $20 billion of cash as of the latest quarter)and the ability to borrow at exceptionally low rates (it just issued commercial paper at1.42% last quarter). Assuming Microsoft earns 3% on current cash and pays a 30% taxrate, Microsoft could pay Yahoo over $15 billion upfront in this transaction and the dealwould still be accretive to Microsofts earnings per share. Over time, with this newcritical mass, we expect Microsoft would be able to gain meaningful share from Google(as many advertisers could eagerly re-allocate their ad spending to a strong number twoplayer), making this deal even more attractive in future years.

What is the bottom line of this proposed deal for Yahoos shareholders? On an after-tax

basis, the $15 billion payment from Microsoft would be $9 billion for Yahooshareholders, leaving Yahoo with $21.2 billion of cash and investments (up from $12.2billion today) and annual EBITDA of $2.4 billion (up from the midpoint of currentguidance of $1.9 billion). Applying a 5x EBITDA multiple on the "new Yahoo" wouldresult in a value of $24 per share. If Yahoo were to go a step further and deploy the $9billion in new cash to publicly tender for its own shares at a $16 offer price, it couldreduce its share count by 40% which would leave the remaining shareholders with a stockvalue approaching $30 per share (amazingly close to the original bona fide bid fromMicrosoft).

Value of Proposed Search Deal to Yahoo Shareholders(in millions)

Existing EBITDA (midpoint of currentguidance)

$1,900

Incremental EBITDA from proposed deal 482

Pro Forma EBITDA $2,382

Multiple of EBITDA 5.0x

Pro Forma enterprise value $11,910

Existing net cash and investments $12,190

New cash from proposed deal (after tax) 9,000

Pro Forma total equity value $33,100

Shares outstanding 1,388

Pro Forma value per share $24

Value to Yahoo Shareholders with Share Tender(in millions)


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Share reduction from $9bn tender at $16/share (563)

New shares outstanding 825

Pro forma equity value with share tender $24,100

Pro forma value per share with share tender $29

Note that our assumptions and estimates are based on publicly available data andstatements from both companies. Even accounting for a reasonable margin of error inour estimates and assumptions, there is no question the proposed deal wouldsignificantly increase shareholder value (up to a 140% increase compared to thecurrent trading price).

We believe that there are no other viable strategic options for Yahoo that come close tothis proposed transaction. Buying AOL (a declining business) will not enhanceshareholder value; in fact, we adamantly believe it would destroy shareholder value.Further, the Department of Justice has made it clear that any workable deal with Googleis not going to be approved. Simply focusing on improving the current business does

not appear to be a realistic option given Yahoo's track record of poor execution andcontinual loss of key employees. Based on our analysis, Yahoo would have to nearlytriple its annual EBITDA over the next 5 years and then achieve a robust multiple of8x EBITDA in order for the stock to be worth more on a net present value basis (using adiscount rate of 15%) versus doing a search deal with Microsoft today.

We understand that occasionally a company must take its time and create options inorder to be in a better negotiating position to deal with a potential bidder. However, inthis case it is clear to everyone and, more importantly, to Microsoft that no other viablealternatives exist. Fortunately, we and the market believe that this deal is just asimportant to Microsoft as it is to Yahoo shareholders. For all of the criticisms that Mr.

Ballmer has received regarding his handling of the Yahoo deal, we believe he has beenclear, fair and reasonable. Rather, it is Yahoo's Board and management team that appearto be acting unreasonably. Microsoft was willing and able to buy Yahoo last Februaryfor $31 per share, which represented a healthy premium of over 60% above Yahoosstock price at that time. Since Yahoo declined that offer, Mr. Ballmer has been willing toengage in discussions to buy Yahoos search business, but Yahoo has decided against thatoption, choosing instead to enter into the Google search agreement (which wassubsequently terminated due to regulatory concerns). There is no question in our mindsthat Microsoft has a strong strategic interest in Yahoos search business. Indeed, Mr.Ballmer has said so publicly, even as recently as December 5th in an interview in theWall Street Journal. Based on Mr. Ballmers actions and words, we believe he is

interested in doing a fair deal for both parties and that he would likely pay more if thedeal were to be completed expeditiously.

One of your Board members, Mr. Icahn, has publicly stated that he supports a search dealbetween Microsoft and Yahoo. Considering the fact that (1) you arguably misplayedyour hand by losing the initial $31 per share offer, (2) the stock is down over 60% fromthat price (vs. a broad market decrease of around 35%), and (3) Microsoft is still reachingout to do a search deal, we urge the remaining Board members to commence constructive


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discussions with Microsoft immediately. This time around, the Board cannot allowanother tremendous value creation opportunity to slip by.

Thank you for your consideration.

Ivory Investment Management, LPCurtis Macnguyen, Managing Partner

About Ivory Investment Management, L.P.

Ivory Investment Management, L.P. is a research-intensive, fundamental value-basedinvestment firm founded in 1998. Ivory currently manages two absolute return strategiesthat focus on investment opportunities in the equity and debt markets. The Firm employsa proprietary risk management process that seeks to generate portfolio returns with lowcorrelation to market indices. Ivory currently employs more than 40 professionals and

manages approximately $3.5 billion of investment capital. The Firm is headquartered inLos Angeles and also maintains an office in New York City. Ivory is a registeredinvestment adviser with the Securities and Exchange Commission.www.ivorycapital.com

ivory press release.12.10.08

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