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What Should Yahoo Do?

Yahoo could throw up a series of defenses against a proposed takeover by Microsoft in next few weeks, but most say the likely outcome will be a higher price from the software giant and a deal.

Yahoo!'s headquarters in California.
Paul Sakuma
Yahoo!'s headquarters in California.

Fighting Microsoft's $31-a-share offer in a friendly way could see Yahoo argue the bid, made Friday, undervalues the Internet company, which could ultimately lead to talks and a higher bid from Microsoft .

Or Yahoo could take an aggressive stand with the aim of staying independent, arguing a deal with the software giant could create a clash of cultures and fail antitrust tests.

Yahoo has said it has not decided whether to accept or rebuff the overture.

"The best strategy would be to try to find some thought of a competing bid," said Joel Greenberg, partner and co-chair of Kaye Scholer's Corporate and Finance Department. "Any suggestion that there's someone else out there is the best possible way to increase the price."

There's been some talk of interest from other potential bidders or a partnership with Google . However, analysts see that as an unlikely scenario.

Citigroup, in a research report Tuesday, gave the chance of another bidder emerging at just 5 percent and saw a 25 percent chance that Yahoo would hire Google to run its search operations.

Citigroup said it sees the likeliest outcome, at a 40 percent chance, for Yahoo to reject the initial offer and Microsoft to raise its bid.

"Do What is Needed"

UBS said in a research note that Microsoft "will do what is needed to get this deal done."

"In a hostile deal the acquirer usually does not lead with its best and final offer and we would not be surprised to see Microsoft sweeten the pot somewhat to make the decision easier for Yahoo's board," the investment bank wrote.

One investment banker not involved in either side speculated that a typical strategy would see Yahoo try to attract another bidder.

If that fails, Yahoo could try and claim it can create more shareholder value by staying independent and striking alliances, perhaps with Google. That would increase pressure on Microsoft to up its bid.

Yahoo's first defense move could be to argue that $31 a share is an unfair price, supported by a valuation report prepared by the company's investment bankers, who are likely working round the clock on the firm's strategy.

Yahoo hired Goldman Sachs and Lehman Brothers to represent it, according to research firm Dealogic.

Yahoo has some takeover defense at its disposal, as it has a poison pill. But it does not have a classified board, a mechanism allowing board members to serve for different term lengths rather than being reelected annually.

Microsoft could get board control at one meeting if it were to launch a proxy fight for board seats, and could put some time pressure on Yahoo.

"One of the things Yahoo has to be very concerned about is ... its shareholder composition," said Greenberg. If that shifts so investors are in the stock only for arbitrage reasons, they'd have "a shareholder population that won't tolerate sitting still."

Yahoo could argue for a higher mix of cash in the offer price, or some protection against movement in Microsoft's stock, which has fallen since it announced its bid, reducing the value of the $44.6 billion offer to about $42 billion.

Wow Factor

The 62 percent premium bid that Microsoft offered could help hurry things along, some thought.

"I think the deal makes sense for Microsoft and I think Microsoft wants to do the deal strongly and will therefore find a way to make it happen," said Ken Allen, an investment analyst at money manager T.Rowe Price.

He expects it won't take too long for a conclusion to be reached.

"I think that's why they offered a 62 percent premium," Allen said. "I think they wanted to make it somewhat of a 'wow' offer in the first place to try and stimulate it to happen quickly."

Shareholders disagreed over what Yahoo should do next.

Mike Binger, a fund manager at Thrivent Financial in Minneapolis, who owns both Yahoo and Microsoft shares in client portfolios, said Friday that it would be very hard for Yahoo as a stand-alone entity to grow its stock to $31 in the next few years. He argued $31 was a "very fair price for the state of Yahoo's business fundamentals right now."

But two institutional investors holding Yahoo shares who declined to be named thought the company should reject the offer and start a dialogue with Microsoft to extract a higher bid.

--CNBC.com has business relationships with both Yahoo and Microsoft.

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