If you own Yahoo stock, should you sell now or hold out for a potentially higher price?
Microsoft is offering a combination of cash and its own stock for all of Yahoo's shares. The value of the offer can change because of the stock component.
It has fallen from $31 per share when the offer was announced Feb. 1 to about $29.
That's still a hefty premium - 51 percent - from where Yahoo was trading before the announcement ($19.18).
If you sell your Yahoo stock today, you can cash in on that premium and reinvest in something else. But you run the risk that a higher offer will surface.
If you wait, you might make a little more money but run the risk that regulators block the deal or that Microsoft walks away. Yahoo's stock would probably tank if the deal fell through.
If your shares are not in a retirement account, you'll also have to weigh the tax impact of taking the bird in hand versus waiting for two in the bush.
To help shareholders weigh the choices, here are some questions and answers:
Q: What is Microsoft offering?
A: For each share of Yahoo, Microsoft offered to pay either $31 in cash, or roughly 0.95 of a share of Microsoft, which also was worth $31 per share initially.
In the aggregate, Microsoft offered to pay half in cash and half in stock.
Shareholders could choose to receive all cash or all Microsoft stock, but there's no guarantee they'd get what they asked for.
What usually happens is that the acquiring company pro-rates stock and cash depending on demand for the two options.
If Microsoft stock rose above $31 per share, almost everybody would choose stock. Microsoft would pro-rate the payout and everyone would receive roughly half in stock and half in cash, says Roy Behren, co-manager of the Merger Fund.
On the flip side, if Microsoft stock fell below $31, almost everybody would ask for cash and still end up getting roughly half cash and half stock.
Not knowing exactly what you would get is another risk to waiting. However, "You can be assured that you won't get less than half in cash if you choose all-cash or less than half in stock if you choose all stock," says John Orrico, co-manager of the Arbitrage Fund.
Q: How do I figure out how much the offer is worth?
A: First multiply Microsoft's current share price by 0.475 (half of the 0.95 exchange offer). Add that to $15.50 (half of the $31-per-share cash offer).
On Friday, Microsoft stock closed at $28.56, placing the value of the offer at roughly $29.07 per share.
Yahoo closed Friday at $29.20 per share.
Q: Why is Yahoo trading above the offer price?
A: Because investors think a higher offer is coming.
Normally a takeover target trades below the offer price while a deal is pending. That's because the deal could fall through and because of the time value of money.
Most big deals take at least six to 12 months to go through. If Yahoo is trading at $29 and the takeover offer is $29, a rational investor would sell Yahoo, reinvest the proceeds and earn a return on that money in the time it takes the deal to close.
"The only reason (Yahoo) trades at $29 is because the market anticipates something better is coming. Otherwise it would trade at $26," Orrico says.
Q: Is a higher offer coming?
A: Maybe, maybe not.
It's possible that another company, often referred to as a white knight in merger scenarios, could offer a higher price. But few have the money and motivation that Microsoft does.
Among the possible suitors, Comcast and Rupert Murdoch's News Corp. have said they're not interested, Google would face an even bigger antitrust hurdle than Microsoft and Time Warner is not likely to want another Web portal given its disastrous experience with AOL.
AT&T has the financial wherewithal and has a broadband partnership with Yahoo. But because it doesn't operate a Web portal, it doesn't have the same cost-saving opportunities that Microsoft has with its portal MSN.
Last year, a private-equity firm might have swooped in, but financing for debt-financed buyouts has become extremely difficult. In recent months, private-equity investors have abandoned proposed takeovers of SLM (better known as Sallie Mae), United Rentals and Harman International, causing their stocks to sink.
The company most likely to offer a higher price is Microsoft.
Many analysts say the $31-per-share offer was already generous. Larry Witt of Morningstar estimates that Yahoo, on its own, is worth only $26 per share.
Yet many predict Microsoft will raise its offer by a few bucks per share to win over directors, employees and shareholders and get the regulatory process moving.
Citigroup analysts say a higher offer by Microsoft is the most likely of five scenarios. "Our view can be approximately summarized as a 65 percent chance that a ... deal is completed, with the stock appreciating to the low to mid-$30s, and a 35 percent chance that a deal does not occur, with the stock retreating to the low to mid-$20s," they said in a research note.
UBS analysts predict Microsoft will raise its offer to $34 per share "to make the decision easier for (Yahoo's) board."
Orrico put the odds of a white knight coming in at less than 20 percent and the chance of a higher Microsoft offer at 50 percent.
Behren predicts that Microsoft "will provide additional value via extra cash, extra stock or price protection via some collar mechanism." A collar would fix the value of the deal as long as Microsoft stock stayed within a certain range. That would remove some risk for Yahoo shareholders but also some upside potential.
Q: Will antitrust regulators approve the deal?
A: Probably, but it won't be quick or easy.
Microsoft says it expects to close the deal in the second half of this year.
"We deem this timeline as particularly aggressive," Leland Westerfield of BMO Capital Markets says in a report. He says, "the Department of Justice and the European Commission will require a much lengthier period for evaluation than assumed by Microsoft."
Westerfield expects the deal to be completed, but no sooner than mid-2009. The Citigroup analysts also don't expect to see the deal completed before 2009.
If the case drags on, there's a risk that the new administration won't be as friendly to business as President Bush's has been.
Q: Should I wait around?
A: Many institutional shareholders, when a takeover is announced, immediately sell their stake in the target company. They "don't want to play the risk associated with capturing a tiny spread," meaning a possible improvement over the initial offer price, Orrico says.
These shares are often purchased by professional arbitrageurs, who make a living betting on the outcome of mergers.
"Anywhere from 10 to 60 percent of shares turn over to arbs and event-driven investors," Orrico says.
Westerfield advises shareholders to take the money and run. He says that "meaningful further upside (greater than 30 percent) from here would depend upon rival white knight counteroffers; we see none emerging." He does see Microsoft boosting its bid to $34 or $35, "but only after a protracted negotiation period. And while that range would suggest a (roughly) 20 percent upside from current price levels, we consider the downside exposure ... as an unfavorable risk-to-reward."
Orrico, on the other hand, says, "I'd stick it out." Yahoo shareholders "have the opportunity to both realize a premium for their shares and at the same time participate in any upside if Microsoft shares went up. I think there's a very high likelihood that Microsoft is successful. I don't see Yahoo trading down to (preoffer levels.) There is a chance Microsoft will increase the value of the proposal. It does seem the potential gain is bigger than the potential downside."
Q: What is the tax impact if I own Yahoo in a taxable account?
A: There might be a tax benefit to waiting.
If you sell now, you will realize a capital gain or loss. Your profit will be taxed as ordinary income (if you held Yahoo one year or less) or at the lower, long-term capital gains rate (if you have held it more than one year.)
However, in most takeovers that involve stock swaps, shareholders usually can defer capital gains tax by converting shares in the old company to shares in the new company. Shares exchanged for cash would still be taxable. If you have a sizable position, contact a tax adviser.