What is Carl Icahn's Exit Strategy with Yahoo?

Today, Carl Icahn, corporate raider par excellence, announced that he would wage a proxy contest with Yahoo. At first glance, he may appear to have a strong hand to play, given that Yahoo just spurned a merger offer from Microsoft without announcing any detailed alternative for enhancing shareholder value. Many disappointed shareholders may be tempted to side with Icahn, who has a proven record of making short term profits from corporate changes of control.

But will those profits come easily by waging a proxy contest with Yahoo? There's only one obvious buyer for Yahoo, and that's the one that just walked away. Icahn reportedly contacted Microsoft and asked if it would be interested in renewing its offer. Microsoft supposedly was noncommittal. That's not surprising. Microsoft, if it is still a potential buyer, would want to get Yahoo for the lowest price possible. Making any kind of promise or commitment to Icahn would only limit Microsoft's options.

Microsoft would be wise to tread carefully now. It walked away from waging a proxy contest itself, probably because there are many shareholders who remain loyal to Yahoo's management and because of the fluid nature of the Silicon Valley. Given the highly competitive and entrepreneurial nature of the Silicon Valley, there's always someone out there who is looking to hire Yahoo's best employees. If the best and brightest at Yahoo got nervous about working for a New York corporate raider or a corporate behemoth headquartered hundreds of miles away in Redmond, Washington, they can have dinner with one or two other companies and be at a new job in a few weeks. Carl Icahn is a tough customer, and if the roughhousing he will surely give Yahoo scares away some of its most capable people, there may not be enough of Yahoo left to interest Microsoft. After all, an Internet company's only real asset consists of its people.

Microsoft evidently was interested in buying Yahoo, in order to keep its book of advertisers away from Google. However, a search engine's relationship with advertisers is often the shortest end of the short term. A lot of advertising space is auctioned on an ongoing basis, and advertisers can decide on the spur of the moment whether or not to run their ads, simply by adjusting the price they're willing to pay. While Yahoo does have a significant amount of "fixed" (i.e., banner) advertising, this largely undirected advertising isn't likely to see growing revenues in the future. Yahoo's advertisers can easily take their business elsewhere. Certainly, Icahn's presence wouldn't encourage them to spend more money on Yahoo. Frankly, neither would Microsoft's acquisition of Yahoo; witness how MSN's been notably unsuccessful in attracting Internet advertising.

So perhaps Steve Balmer's best decision in this whole scenario was to walk away from Yahoo. And maybe he won't change his mind if Icahn wins his proxy contest, because Yahoo could be seriously damaged goods by the time the proxy contest is over.

In that case, what does Icahn do? There aren't any other high tech companies that are obvious buyers for Yahoo (except Google, which would face insurmountable antitrust problems, either in Washington, D.C., Brussels or both). Main Street corporations probably wouldn't want to touch Yahoo, not after seeing how things went with Time-Warner's acquisition of AOL.

Moreover, Yahoo isn't like a lot of conglomerates found on Main Street. It doesn't consist of disparate subsidiaries and lines of business that can be sold off separately at a nice profit. Yahoo provides a bunch of services that draw customers from each other. These services are supposed to provide synergies that produce a whole greater than the parts. It wouldn't be easy to strip them off from the corporate parent and sell them piecemeal. With the economy slowing and advertisers becoming more selective about how they spend, Yahoo's constituent pieces may not command premium prices. The sell-off-the-valuable-assets strategy that Icahn pursued with TWA couldn't easily be applied here.

To make things worse, the credit crunch on Wall Street would probably preclude other exit strategies Icahn might have pursued in the past. Yahoo would likely have a hard time getting the financing for a recapitalization and share buyback program of a magnitude that would satisfy the Icahns among its shareholder base. Financing for corporate deals has been tightening up since last summer. With Yahoo's less than glowing performance in recent years, lenders might pause before taking this plunge.

So Icahn has only one good shot here: win the proxy contest and sell Yahoo to Microsoft. If Balmer can buy Yahoo cheaply enough, he'd probably still proceed. Of course, that's the last thing that Icahn would want. Carl Icahn doesn't wage proxy contests so other people can make a lot of money. He's in it for himself, and would seek a premium price from Microsoft. But Icahn holds a weaker hand than Microsoft. Microsoft has an enormous cash flow and a gigantic cash hoard, and can easily survive without Yahoo. It may be on a path of gradual long term decline, as newcomers like My Space and Facebook, and a resurgent Apple, grow. But Microsoft needs a Yahoo deal a whole lot less than Icahn (who may well have bought Yahoo stock with borrowed money and could therefore have interest charges building up with each passing day). Icahn's looking for a short term play. But if he actually wins the proxy contest, he'll probably be in a weaker position to negotiate a high price than Yahoo's management (and recall how successful they were).

So be cautious about buying Yahoo stock now, in the expectation of Icahn producing a profit for you. He's tough and resourceful, but so are his adversaries. He could lose this proxy contest. And even if he won, Yahoo may be so battered that he won't be able to sell it for a great price.