Yahoo vs. Microsoft: Thanks for the letter Steve; Now give us more money or get lost

Yahoo on Monday responded to Microsoft's weekend "negotiate or we're launching a proxy war or pulling our offer" love letter. The gist: Increase your offer or get lost.

Give credit to Yahoo for sheer moxie (or maybe it's stupidity). But Microsoft CEO Steve Ballmer can't be happy following Yahoo's response. Ballmer plays hard ball and gives Yahoo a three-week ultimatum. Yahoo doesn't blink and wants nothing to do with Microsoft. Yahoo CEO Jerry Yang even mentioned AMP, the company's latest ad platform as a reason to toss in a few more bucks a share.

• Microsoft's $31 a share offer is too low.
• Our optimistic outlook through 2010 is legit.
• Microsoft's shares have fallen to so your offer is worth less today.
• Despite an economic slowdown, Yahoo's results are on track to hit estimates.
• There are antitrust issues still.
• And Steve you're full of it.

Yahoo writes: "Your comment that we have refused to enter into negotiations to conclude an agreement are particularly curious given we have already rejected your initial proposal, nominally $31 per share at the time, for substantially undervaluing Yahoo! and your suggestions in your letter and the media that you are considering lowering the value of your proposal. Moreover, Steve, you personally attended two of these meetings and could have advanced discussions in any way you saw fit."

Analysts maintain that this game of chicken between Microsoft and Yahoo will result in a deal. Merrill Lynch analyst Justin Post writes in a research note:

Yahoo’s inability to find a credible alternative and Microsoft’s weakening stock price since the deal was announced make a substantial increase in the offer price much less likely, in our view. We believe a deal, however, is still likely based on the rationale that search is a scale game, Yahoo! is still losing usage market share (despite positive monetization trends), and Microsoft needs to bolster their online advertising capabilities as computing becomes more Net-centric. Yahoo's "white knight" scenarios and aggressive three year EBITDA projections have been viewed as somewhat unrealistic by most investors.

Here's the full text of Yahoo's letter and Microsoft's Saturday missive.

Dear Steve:

Our Board has reviewed your most recent letter with regard to the unsolicited proposal you made to acquire Yahoo! on January 31, 2008.

Our Board carefully considered your unsolicited proposal, unanimously concluded that it was not in the best interests of Yahoo! and our stockholders, and rejected it publicly on February 11, 2008. Our Board cited Yahoo!’s global brand, large worldwide audience, significant recent investments in advertising platforms and future growth prospects, free cash flow and earnings potential, as well as its substantial unconsolidated investments, as factors in its decision.

Translation: Our outlook isn't BS.

At the same time, we have continued to make clear that we are not opposed to a transaction with Microsoft if it is in the best interests of our stockholders. Our position is simply that any transaction must be at a value that fully reflects the value of Yahoo!, including any strategic benefits to Microsoft, and on terms that provide certainty to our stockholders.

Translation: Show us the money.

Since disclosing our Board's position with respect to your proposal, we have presented our three-year financial and strategic plan to our stockholders, which supports our Board’s determination that your unsolicited proposal substantially undervalues Yahoo!. Those meetings with our stockholders have also provided us an opportunity to hear their views.

We have continued to launch new products and to take actions which leverage our scale, technology, people and platforms as we execute on the strategy we publicly articulated. Today, in fact, we are announcing AMP! from Yahoo!, a new advertising management platform designed to dramatically simplify the process of buying and selling ads online.

Translation: To you AMP is another thing to integrate (giggle). But it may make us a player.

Finally, our Board has been actively and expeditiously exploring our strategic alternatives to maximize stockholder value, a process which is ongoing. All of these actions have been driven by our overarching commitment to maximize stockholder value.

Translation: No one else is matching your offer, but we'll gloss over that. We're still working on this AOL thing.

Our Board's view of your proposal has not changed. We continue to believe that your proposal is not in the best interests of Yahoo! and our stockholders. Contrary to statements in your letter, stockholders representing a significant portion of our outstanding shares have indicated to us that your proposal substantially undervalues Yahoo!. Furthermore, as a result of the decrease in your own stock price, the value of your proposal today is significantly lower than it was when you made your initial proposal.

Translation: Your stock price has been dinged too. So there!

In contrast to your assertions about the effect of general economic conditions on our business, Yahoo!'s business forecasts are consistent with what we outlined in our last earnings call. As you know, we recently reaffirmed our Q1 and full year guidance, which is a testament to our ability to perform in line with our expectations despite the current economic environment. In addition, our three-year financial and strategic plan which we have made public demonstrates significant potential upside not previously communicated to the financial markets. This plan has received positive feedback from our stockholders, further strengthening the view that Yahoo! is worth well more as a standalone company than the value offered in your proposal, and would be even more valuable to Microsoft. Your own statements have made clear the strategic importance of Yahoo!'s substantial assets and capabilities to Microsoft.

Translation: You need us more than we need you.

We regret to say that your letter mischaracterizes the nature of our discussions with you. We have had constructive conversations together regarding a variety of topics, including integration and regulatory issues. Your comment that we have refused to enter into negotiations to conclude an agreement are particularly curious given we have already rejected your initial proposal, nominally $31 per share at the time, for substantially undervaluing Yahoo! and your suggestions in your letter and the media that you are considering lowering the value of your proposal. Moreover, Steve, you personally attended two of these meetings and could have advanced discussions in any way you saw fit.

Translation: Steve, you're making stuff up. If you want to get ugly we'll get ugly.

As to antitrust, we have discussed with you our concerns. Any transaction between us would result in a thorough regulatory review in multiple jurisdictions. As a follow up to a recent meeting among our respective legal advisors we had on this topic, and at your request, we provided to you on March 28 a list of additional information we would need to further our understanding of the regulatory issues associated with any transaction. To date, you have still not provided any of the requested information.

We consider your threat to commence an unsolicited offer and proxy contest to displace our independent Board members to be counterproductive and inconsistent with your stated objective of a friendly transaction. We are confident that our stockholders understand that our independent Board is best positioned to objectively and knowledgeably evaluate our Company's alternatives and to maximize value.

Translation: We're ready for a proxy war.

In conclusion, please allow us to restate our position, so there can be no confusion. We are open to all alternatives that maximize stockholder value. To be clear, this includes a transaction with Microsoft if it represents a price that fully recognizes the value of Yahoo! on a standalone basis and to Microsoft, is superior to our other alternatives, and provides certainty of value and certainty of closing. Lastly, we are steadfast in our commitment to choosing a path that maximizes stockholder value and we will not allow you or anyone else to acquire the company for anything less than its full value.

Very truly yours,

Roy Bostock, Chairman of the Board

Jerry Yang, Chief Executive Officer

And for background, here's Microsoft's Saturday love letter to Yahoo.

April 5, 2008 Board of Directors Yahoo! Inc. 701 First Avenue Sunnyvale, CA 94089

Dear Members of the Board:

It has now been more than two months since we made our proposal to acquire Yahoo! at a 62% premium to its closing price on January 31, 2008, the day prior to our announcement. Our goal in making such a generous offer was to create the basis for a speedy and ultimately friendly transaction. Despite this, the pace of the last two months has been anything but speedy.

While there has been some limited interaction between management of our two companies, there has been no meaningful negotiation to conclude an agreement. We understand that you have been meeting to consider and assess your alternatives, including alternative transactions with others in the industry, but we’ve seen no indication that you have authorized Yahoo! management to negotiate with Microsoft. This is despite the fact that our proposal is the only alternative put forward that offers your shareholders full and fair value for their shares, gives every shareholder a vote on the future of the company, and enhances choice for content creators, advertisers, and consumers.

During these two months of inactivity, the Internet has continued to march on, while the public equity markets and overall economic conditions have weakened considerably, both in general and for other Internet-focused companies in particular. At the same time, public indicators suggest that Yahoo!’s search and page view shares have declined. Finally, you have adopted new plans at the company that have made any change of control more costly.

By any fair measure, the large premium we offered in January is even more significant today. We believe that the majority of your shareholders share this assessment, even after reviewing your public disclosures relating to your future prospects.

Given these developments, we believe now is the time for our respective companies to authorize teams to sit down and negotiate a definitive agreement on a combination of our companies that will deliver superior value to our respective shareholders, creating a more efficient and competitive company that will provide greater value and service to our customers. If we have not concluded an agreement within the next three weeks, we will be compelled to take our case directly to your shareholders, including the initiation of a proxy contest to elect an alternative slate of directors for the Yahoo! board. The substantial premium reflected in our initial proposal anticipated a friendly transaction with you. If we are forced to take an offer directly to your shareholders, that action will have an undesirable impact on the value of your company from our perspective which will be reflected in the terms of our proposal.

It is unfortunate that by choosing not to enter into substantive negotiations with us, you have failed to give due consideration to a transaction that has tremendous benefits for Yahoo!’s shareholders and employees. We think it is critically important not to let this window of opportunity pass.

Sincerely, Steven A. Ballmer Chief Executive Office Microsoft Corp.