The Microsoft-Yahoo deal implosion was a near certainty when the talks began. Two cultures as convinced that they are superior to one another can never coexist, so forget blaming anyone for what was inevitable. At least it didn't take two years and billions of dollars in real losses, as compared to the short-term deflation of Yahoo share values after the negotiation ended.
The question today, though, is what company should you buy in light of this "change of fortune" for Microsoft, for Yahoo and, for Google, which could benefit from a Yahoo ad deal in coming weeks or months?
All three are profitable. All three had better Q1 results year-over-year than 95% or more of publicly traded companies. In Yahoo's case, the company made almost four times the profit it did a year ago, while Google's net income increased by 30 percent and Microsoft's fell by 11 percent. Each company is at a different point in its management of resources. We can clearly see that Yahoo cost-cutting has yielded positive results. Google's been slowing hiring a bit lately, which will increase margins in future quarters as it continues to enjoy ad revenue growth based on its dominant position. And Microsoft? Well, they have a great mountain of cash they will eventually use to buy a line of revenue.
But if you look at their trailing and forward Price-to-Earnings ratios, we can see that the great risk remains with Yahoo:
Trailing P/E (8:10 AM Pacific, 5/52008) Forward P/E (source Capital IQ)
Google 41.76 24.01
Microsoft 17.36 13.83
Yahoo 31.65 42.79
Yahoo has to grow revenue to break out of its current situation, whereas both Google and Microsoft merely have to continue on their current paths to remain attractive to investors. However, both Google and Microsoft have grown used to expansion as a way of life, which is not assured in the current economy. Yahoo, on the other hand, could lower costs and add new revenue by opting for a Google ad partnership, allowing the company to shed a lot of sales costs, which might bring its margins up into the 24 percent to 28 percent where Google and Microsoft operate today. Google, of course, would win in that situation, as well.
Meanwhile, it is Microsoft that has the most work to do to convert its massive capital expenditures and staffing costs into higher profits. For all its software revenues, the Redmond giant is the most moribund of the three. Microsoft needs a major innovation of its own, or to acquire one, to kickstart rapid growth. Of course, if Microsoft does put its cash to work in a productive way (something I doubt will happen, because it has become too conservative), the potential for returns are much higher than with Google (relatively over-valued based on trailing P/E) and Yahoo (over-valued today and in the future, based on trailing and future P/E).
So, if I were buying today, I think I'd put money into all three, about the same amount into Microsoft than Yahoo, and the largest share into Google, so that I was prepared to benefit from any of the next moves these companies make.
The long and short of it is: None of these companies has "lost" the game, and each has potential to become bigger than it is today. Only Microsoft stands to lose value on its income statement in the short term. And who gives a damn what the market thinks when so many people are chattering away based on prejudices and misconceptions about Microhoo today?