Is there ever a dull moment for Yahoo (YHOO) stock owners?
Less than two weeks out from the Alibaba (BABA) IPO that translated into a windfall for Yahoo, managers of hedge fund Starboard Value LP — a major YHOO shareholder — penned a public letter to CEO Marissa Mayer explaining how she had failed to unlock enough value from Yahoo stock, and what she could do to rectify the mistake.
And while the letter was professionally presented, Starboard Value managing partner Jeffrey Smith didn’t pull any punches when discussing the company’s failings and opportunities.
The letter proposed one particularly interesting idea, however … an idea investors surprisingly didn’t jeer and sneer at. Smith suggested YHOO partner up with AOL (AOL), and perhaps even merge with it. Smith estimated the union could result in as much as $1 billion in cost synergies.
Just because a veteran activist investor says it, however, doesn’t necessarily make it so.
Highlights From the Starboard Value Letter to Mayer and Yahoo
While the letter from Smith to Mayer was a 2,500-word diatribe that touched on a variety of topics, at its core, it was about one thing — now that the Alibaba IPO is history, Yahoo needs to work quickly and diligently if it wants to remain viable. As Smith put it:
“The appreciation in Alibaba’s valuation, which Yahoo purchased in 2005, has masked the poor performance of Yahoo’s core business … since new management was appointed in Q2 2012, revenue in Yahoo’s core Search and Display businesses has been stagnant, yet SG&A and R&D expenditures have grown by a staggering $390 million, in turn, causing EBITDA to decline by 19%. … Our analysis indicates that Yahoo’s display business, where management’s efforts and acquisitions have been focused, may be losing over $500 million in EBITDA per year. We believe such unacceptable financial performance has resulted from a combination of the Company’s large investments in content and new products along with a continued decline in Display advertising pricing and a bloated cost structure.”
The solution? The Smith letter continued …
“Interestingly, based on our research and the legal advice we have received on how to unlock the value of Yahoo’s equity holdings, we believe a merger of AOL and Yahoo’s core business may be one of the best ways to both fully seize the cost reduction opportunity and also to tax efficiently monetize Yahoo’s non-core equity holdings.”
The theory is, the pooling of the companies’ resources would not only reduce costs, but make each better equipped to succeed in new areas — like mobile — while simultaneously capitalizing on what Smith describes as “enhanced relationships with advertising agencies.” It all seems sound on the surface.
But there may be a major flaw in the theory.
AOL + YHOO = No Better Off
Kudos to Starboard Value for creativity, but Yahoo and AOL can’t fix each other if they can’t fix themselves first.
A solution becomes even less likely in this case, as it seems unlikely that either of the two companies — or their CEOs — will actually be willing to do the “giving” part of what will most definitely need to be a “give and take” relationship.
Jeffrey Smith is exactly right on a couple of points. He’s right about Yahoo’s core search and display businesses being stagnant in step with a continued decline in display advertising pricing. He also was (likely) right to believe “AOL’s display business also continues to lose a substantial amount of money.”
Where he is almost certainly wrong, though, is in his assumption that the combination of two struggling companies — especially those with well-defined company cultures — results in a thriving one; at least one of the organizations has to be competent enough to lead the other through a major overhaul. Without that competency and open-mindedness in place, the union of two companies could result in nothing but chaos.
Case(s) in point: AOL & Time Warner (TWX), Alcatel and Lucent becoming Alcatel-Lucent (ALU), the creation of DaimlerChrysler, Sprint (S) and Nextel, and several others. All were lauded ideas when they were mere ideas, like the premise of merging AOL and Yahoo now.
After these mergers became reality, they became unmitigated disasters.
While there may have been functional/technical reasons for these failed unions, in retrospect, the reason these mergers failed can be pinpointed to one of two (if not both) causes: a clash of corporate cultures, and a clash of CEO egos.
There’s little doubt both AOL and YHOO are sitting on more than their fair share of entrenched company culture and personal ego.
As evidence to the egos, when Marissa Mayer showed up an hour-and-a-half late to a meeting with some IPG executives in June (the other parties were on their way out the door when she finally showed up), she essentially laughed off her insulting (albeit accidental) gaffe rather than being as gracious about it as she should have been.
As for AOL CEO Tim Armstrong, while his ego is more of the “always justified” variety and less of the arrogant type, it’s still dangerous. For example, in February of this year, Armstrong announced a significant cut in employee retirement benefits. While unfortunate, such cuts aren’t uncommon. What was uncommon was Armstrong’s willingness to explain that at least some of the reason to cut benefits was blamed on expensive “distressed babies” (his words) being born to AOL employees who had the gall to use their insurance benefits. He later apologized for the unnecessary and potentially cruel comments, but it’s still proof that sometimes the best thing to say is nothing. Perhaps that’s a skill Armstrong has yet to acquire.
Point being, Mayer and Armstrong likely won’t take the subservient position they would need to in order to make a partnership work. The DaimlerChrysler disaster illustrates this danger as well as any example could. That pairing was deemed to be a merger of equals, but neither CEO actually felt that way; both wanted to be the cornerstone of the new company.
Regarding the well-developed and probably unwavering corporate cultures, both companies have been around since the dot-com era of the late ’90s. Even with a few mutations and growing pains in the meantime, each company’s culture has had years to jell. De-jelling and then co-jelling them is a potential powder keg. We learned that all too well from the miserable merger of Sprint and Nextel.
Jeffrey Smith and Starboard Value say it’s a good idea for AOL and YHOO to partner up, and yes, maybe in theory, it does sound good.
But that doesn’t mean the marriage would ever actually pan out.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.