The Microsoft hostile bid for Yahoo in 2008 provides the backdrop to a HBR case that MBA students at the Ted Rogers School of Management were doing in a Corporate Finance course. There were 11 teams of five or six members each in a case competition, where they took on the role of the investment bankers to either Yahoo’s Board of Directors or to Microsoft’s Board. I was invited as one of the judges to that case competition which took place on Nov 7, 2011. What follows is a note I wrote to the students in my personal take on the strategy considerations behind that proposed deal, as well as absolute necessity of disciplined reasoning, and considered attention to human detail in understanding the way business operates in empirical reality.
Thank you for letting me be one of your judges in your recent case competition. It was enjoyable, educative and illuminating for me, as I hope it was for you with you listening to each other and learning in greater detail about the case. I wanted to make a few brief comments on the case, and perhaps as good a starting point as any would be the one word that was common to all the presentations: synergy. This word has become one of the great clichés of businesspeak, where most people know what the word means in a theoretical context, but most people who blandly use it have no clue about what it actually translates to in actual execution. All the teams spoke of possible synergies between Microsoft and Yahoo, but if you recall I was most keen in pressing you to explain what that actually meant in real life terms. I was not asking for technical details but for some common sense, logical ideas on how these synergies were to be achieved, or indeed if they could be achieved at all.
In your role as investment bankers, whether for Microsoft or Yahoo, your role is very similar to that of matchmakers arranging a marriage. Perhaps many of you, especially those of Indian or Asian origins, may have availed yourself of their expertise in helping you find your life partner for a long and happy future. Therefore at a very basic level, you need to see if the partnership will make sense; you cannot just thrust two people into marrying one another, and simply say that they will find “synergies” to make their marriage successful. That would be tantamount to arranging a marriage between a mouse and an elephant, and citing the possibility of their viable offspring to “mouse-and-elephant synergies.” My point is that things have to logically, and logistically, make sense in practical terms before you rush off to your Excel sheets to make all sorts of models. Incidentally how many of your teams had right at their first team meeting for this project with everyone impressively opening up laptops, seriously keying in numbers, or designing Powerpoint slides, or writing factoids on a whiteboard? Any good case meeting starts with a conversation about the companies involved, and whether the proposed recommendation is actionable. Then we can start working on the numbers to test the accuracy of our strategic analysis. To return to the marriage metaphor, we need to see if the couple in question are actually compatible before we start negotiating dowries, pre-nuptial agreements, or wedding gown financing.
So, let’s start with the basics. We can all agree that any Microsoft/Yahoo! Union would be an enterprise that takes on the market leader, Google, and significantly (but not necessarily exclusively) within the search engine business. Unlike in more traditional businesses with long business cycles and entrenched competitors from huge corporate organizations, any major internet-related business has radically short business cycles. The only way a business remains the market leader is because it is significantly better than the competition. Like in the Olympics in Ancient Greece, there were no records kept of the runners-up—just the gold medalists. So, being second-best (or third or fourth-best) is not really an option[1]. Further, just because your business leads in one industry does not mean it can lead in another industry. Take the sad and lamentable story of Blackberry: RIM came up with a secure email communication and internet access innovation that opened up the age of smartphones, and swept up the corporate world[2]. However, when Apple came up with the iPhone, Blackberry suffered a near fatal blow. So, Blackberry tried to respond with its pathetically pathetic Playbook (which was basically a copycat model of Apple’s iPad) and what a disaster that was! My point is that in this business, simply copying or trailing behind the market leader’s innovative product is completely ineffective in so many ways. Steve Jobs famously sneered at Zune and similar MP3 players which emerged to compete with the iPod (and its famous tracking wheel and single button at its center)[3]. All these copycat products ended up simply making their imitation tracking wheels, without understanding or being capable of replicating the design innovation that made the original tracking wheel such a radical and efficient innovation on the human-machine interface—even my daughter at the age of 3 learned how to use my iPod to play her favorite songs. And it is interesting to note that to date, iPhone has the best touch-screen interface in the mobile phone industry. This is innovation!
So, to return to the Microsoft and Yahoo Union (MYU), if there is any intention of competing with Google, then MYU has to create a radical innovation. It is true for any IT-related business, but especially for Google which was no one-hit wonder, but a massively game-changing company, product and service. Indeed, if I may indulge myself, I would divide the history of the internet into two periods, the way we divide western history into B.C and A.D. In the history of the internet, there was the dark ages B.G (Before Google), and the era of light A.G. (After Google). So, that is the level of innovation that is needed if MYU wants to unseat Google. Some of your presentations actually hit on this point—not to simply get some copycat, or unoriginal search engines hopefully (all too hopefully) cooperating in some hokey “synergies,” but an actual game-changing innovation. Good job!
For some of you, that innovation would be the Panama Project advertising system at Yahoo, which may or may not be the next greatest thing since sliced bread, but the key point is that it was still in beta testing. Just think about it. Is there any possible way that a product still in beta will be able to compete with the existing tried-and-tested Google ad-incorporated search engine? Even Google itself rolls out its excellent products in beta, never to compete with market leaders—Google chrome in beta was never competing with Internet Explorer. It was only later that Google chrome became ubiquitous, though Internet Explorer still firmly controls the business world (my work laptop uses only IE, and for security reasons I cannot even download and install Firefox or Google chrome which are vastly better browsers). So, I am not buying the Panama Project “synergies” just yet. And if I am to dip into some of those organizational behavior courses I took during my MBA, I would hazard a reasonable guess that the inevitable cost-cutting due to replication of functions in the new MYU company will definitely drive away a significant portion of Yahoo’s and Microsoft’s top talent right over to Google which is famously known for the loving care with which it treats its employees (if you don’t know about it, simply search for “Top 10 reasons to work for Google,” or should I say more appropriately, google it!). Many of you chose the WACC of Yahoo as a proxy in your valuation to get your price range for the share price, but how realistically accurate of a value is that? Sure, you could do the math, make a lovely financial model, impress Professor Arup that you have mastered DCP and Comps valuations, but at the end of the day do you not think that you may have grossly overpriced Yahoo? If you still remain defensive on this point, I will draw your attention to the sad and lamentable tragedy of AOL Time Warner. This time, you may want to wiki it instead of googling it.
But, let us say, for the sake of argument that MYU aspires to produce a totally insanely great product that will change the face of the internet as we know it. Then the question arises of if this is indeed possible. Let us go visit the hopefully happily married couple of the mouse and the elephant. My guess is that no matter how much they love each other, they may have some challenges making little elephant-mouse babies, and the problems start right from conception, if you pardon the intended pun. Microsoft has a long and established tradition of creating, and foisting on the unsuspecting public, sub-standard products (MS-Windows, Internet Explorer, MS-Office etc). Its business processes and its corporate culture are ruthlessly competitive, with a heavy emphasis on production targets and deadlines rather than on innovative products or elegant design thinking[4]. Yahoo is innovative, and its business processes and products do tap into the cultures of innovation, so much so that it has become the homepage of so many users (who willingly or not get their hourly newsfeed of the sexual peccadilloes of their favorite celebrities). Then, there is of course, Yahoo Finance and Yahoo Auctions which are almost household words etc (at least in business breadwinner households). If Microsoft acquires Yahoo, presumably the Microsoft corporate culture will prevail over the Yahoo culture. Microsoft performance targets, milestones, logistics and ultimately people will prevail over those of Yahoo. Therefore any projections of future growth over the next 3 – 5 years are merely hockeystick projections (Why did you do valuations for 3 – 5 years, and then terminal value after 5 years? Are there any precedent transactions which suggest 3 – 5 years as a suitable growth period?) A valuation of Yahoo, with a recommended purchase price will have to incorporate consideration of not just what Yahoo’s independent current market value is, but more significantly of what its’ value will be to Microsoft once the purchase is completed, and the new MYU starts generating revenues. Of course as Investment bankers, you are duty-bound to present the rosiest, floweriest of financial pictures about projected revenues, but any smart board of directors worth their salt will definitely question the logic behind the numbers. And, in my experience, they don’t get convinced because someone mumbled “synergies” or “cost savings” or any other half-baked justification. Even the famous dean of the Rotman School of Management (and one of the top 50 Leadership Gurus), Roger Martin, earned a comment to one of his Harvard Business Review Blog articles earlier this year, to “put it back in and bake the other half” who signed himself/herself as ‘Incredulous[5].’ The proposal needs to be both actionable and be able to make intuitive sense.
So, to summarize, we first discussed our role in the merger, then we looked at the main competition (i.e. Google). We had to assess how we strategically take on Google, and decided that we need a massively innovative product/service. Then we looked at the logistics of Microsoft and Yahoo working together to actually produce this great innovation, and the likelihood was not encouraging. We also recognized that we have no good precedent transactions on which to base projected future cash flows. Further we recognized that Yahoo’s calculated market value (based on DCF) may not be an accurate proxy measure of how the new MYU company will perform. Your comparative valuations used ratios of comparable deals at the time of purchase, but did not consider how the post-merger actual performance compared with the predicted performance of the proposed pre-merger financial models. So, the key determinant of your valuations, the WACC, was more of what financiers colloquially call a WAG (Wild-Assed Guess). Does that mean that we should simply throw up our hands and say this acquisition won’t work, and why bother anyway? If you wanted to be ethical about it, perhaps you should not even be making this pitch to Microsoft and Yahoo—MYU has got all the signs of a failure about it. However, as a conscientious student at the Ted Rogers School of Management, and as a successful future investment banker, you are going to have to do some valuation, and come up with some price. By having this discussion of the actual strategic realities of the proposed acquisition, you are now in a better position to decide which valuation model to use, address its weaknesses and strengths, you know which numbers to pull off Yahoo’s balance sheets and how much validity to give these numbers, you can make realistic assumptions in your financial models, and in your sensitivity analyses. You will be able to convert the WAG into a SWAG (a Scientifically Wild Assed Guess). And finally, you have done the strategic thinking behind the whole process so that when you go to make your pitch to either Yahoo or Microsoft, you can explain the rationale behind the numbers (which hugely maximizes your chances of selling the board of directors on the deal). In a word, when you say “synergy” you will know exactly what you are talking about, and then it ceases to be a cliché, but becomes a sound business plan upon which you can stake your reputation, and your future success. Thomas Watson, CEO of IBM famously coined the injunction to his employees, Think! (with the red dot on the letter i reminiscent of the red mouse-ball on all IBM personal computers). Even more famously came Steve Jobs with the legendary Apple Commercial and its inspiring message “Think Different”. Good luck!
[1] Jack Welch of General Electric had his famous injunction to all of the GE Business Units to be “first, second, or get out of the business” which made GE the global powerhouse that it was during his period at the helm.
[2] Ted Kernaghan, billionaire philanthropist (and board member of RIM), once bragged to me that “Even the President of the United States carries a Blackberry!” So great were the heights scaled by a small company from Waterloo, Ontario, and which became a worldwide phenomenon.
[3] I highly recommend his posthumously published biography, Steve Jobs: A Biography (2011) by Walter Isaacson, especially now that Indigo is selling it at a discounted price of $25, which gives you some interesting insights into this titanic genius. For a brief preview of the man see my blogpost: https://tonymayadunne.wordpress.com/2011/10/10/lucifer-rising/
[4] I am using the word “elegant” in a very specific design sense of the word. Matthew E. May’s book, In Pursuit of Elegance: Why the Best Ideas Have Something Missing (2009) is a wonderfully readable description and discussion of elegant solutions.
Working with the inner human 