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Court Docs Dish Dirt on Yahoo-Microsoft Wrangling

Yahoo CEO Jerry Yang ordered up a draft press release rejecting a Microsoft takeover bid months before January's unsolicited bid and flip-flopped on spurning an ad deal with rival Google, company documents unsealed on Monday show.

Selective details from Yahoo (NASDAQ: YHOO) board minutes and other confidential company documents in an investor suit, unsealed by a Delaware Chancery Court judge on Monday, paint a picture of how Yahoo has rebuffed Microsoft's (NASDAQ: MSFT) courtship since early 2007.

Attorneys working on behalf of Yahoo investors aiming to force the company to drop its anti-takeover defenses -- opening the way to a Microsoft deal -- got the papers from the company and were allowed by a judge to make them public on Monday.

Minutes of Yahoo's board meeting last October said directors discussed "the likelihood that a third party would make an offer to purchase the company." Yang then obtained approval to reject any offer, drawing up a standby press release for an offer that only arrived late in January 2008. The suit alleges the "third party" was Microsoft.

While many events described in the shareholder complaint have enjoyed wide media coverage over the past year and a half -- dating back to reports of Yahoo's decision to reject a Microsoft offer of $40 per share in January 2007 -- the new disclosures bring to light Yahoo's resistance to a merger.

In notes from a phone conversation between Yang and Microsoft Chief Executive Steve Ballmer held the day before Microsoft made public its takeover bid for Yahoo, Yang sought to delay Microsoft, but Ballmer said he would wait no longer.

"You don't lose anything by waiting a week," Yang is cited as saying, according to notes taken by an unidentified Yahoo participant and released in the shareholder suit on Monday.

Ballmer responded with words to the effect that "If you really don't want to sell the biz, then [I] don't want to wait" according to the previously undisclosed notes of the call. Ballmer also encouraged Yang to make a counterproposal and said Microsoft would forego making its bid public if Yahoo did so.

The records do not indicate whether Yahoo countered. Microsoft went public the following day, Feb. 1, with its $31-per-share cash-and-stock offer, worth nearly $45 billion.

The suit seeks to paint Yang as a Microsoft hater, but Yang's public statements and willingness to meet with Microsoft several times in recent months suggest he is seeking to wring a better price from Microsoft, not scotch a deal at all costs.

"We did not walk away from that proposal, Microsoft did," Yang told a high-tech conference last week. "Microsoft is no longer interested in buying the company, and we are talking about other things," he said, adding that "we are listening."

Flip-flop on Google deal

The court documents also indicate that Yahoo executives dismissed a search-advertising deal with Google (NASDAQ: GOOG) due to antitrust concerns -- although it reversed that position shortly after Microsoft made its bid.

"We are focused on long-term value creation rather than short-term gains," said a Yahoo document prepared for company executives ahead of an "all hands" internal meeting on Jan. 30 -- the day before Microsoft made its merger offer.

Bracing for employee questions over whether Yahoo should outsource its search-ad sales to Google, executives were prepared to argue that any short-term gains would derail Yahoo's long-term push to become a "must buy" for advertisers.

"Short-term analysis of the revenue potential of outsourcing monetization may not take into account the longer-term impact on the competitive market if search becomes an effective monopoly," an excerpt from the company document said. Monetization refers to sales of search-related ads.

These comments appear to contrast with Yahoo's subsequent position when it announced on April 9 that it was conducting a test with rival Google, the market leader in Web search and related advertising, to rely on Google to sell its search ads.

The turnabout on Google was part of a strategy by Yahoo management to seek alternatives for its business instead of settling for Microsoft's cash-and-stock offer at $31 per share, which the company's board had rejected as undervaluing Yahoo's assets.

Microsoft challenged the possible Google-Yahoo tie-up as anticompetitive, citing Google's growing dominance of the Web search business and its even larger share of ad sales tied to Web search results. Government regulators also rushed to say they would investigate any Google-Yahoo partnership.

Web search is increasingly strategic as most people find information on the Internet via such systems. Search-based advertising, because of its high degree of targeting, has become a great money spinner for Google.

Yahoo has acknowledged that a gap exists between what it makes running its own advertising alongside its search results and the improved payback it could see by using Google's ad-sales systems in conjunction with Yahoo's search operation.

"We, in fact, have some understanding of what [Google] could do for us and what we could do for them," Yang told a conference last week.

Suit demands Yahoo drop merger defenses

The attorneys representing two Michigan pension funds are demanding that Yahoo drop barriers to a potential merger deal. They depict Yahoo as rushing to adopt an employee severance plan aimed at derailing a deal, according to their complaint.

Yahoo attorneys had previously asked the Delaware court to seal details from confidential company documents for fear they could be used against Yahoo in an upcoming proxy battle the company faces at its shareholder meeting set for late July.

When first released in mid-May, the amended shareholder complaint had crucial sections redacted. Chancery Court Judge William Chandler III on Monday ruled there was no reason to shield the Yahoo documents from investors and lifted the seal.

In ordering the Yahoo documents to be made public, the judge acknowledged that the plaintiffs may be mischaracterizing some of the facts or otherwise taking them out of context.

[cob:Special_Report]But Chandler dismisses these concerns in ruling that: "The proper remedy is for defendants [Yahoo] to release the full text of any communications they believe have been taken out of context or selectively quoted to the public."

Yahoo said in a statement it was disappointed by the ruling but that it would make no difference in the outcome of the suit, which the company said it believes is without merit.

The bulk of the complaint against Yahoo released on Monday centers on whether the court should cancel a generous employee severance plan that plaintiffs' attorneys argue is nothing more than a move to make any takeover prohibitively expensive.

The suit contrasts a $1.5 billion Microsoft employee retention plan Ballmer mentioned to Yang in their Jan. 31 phone call to Yahoo's quickly arranged employee severance plan that would add an estimated $2.1 billion in costs in the event of a merger. The plaintiffs maintain that Yahoo's severance plan has the perverse effect of keeping Yahoo employees in place for now but would encourage them to leave if Yahoo is eventually sold.

Were Microsoft to offer a $35-per-share price, the Yahoo severance plan would add nearly $2.4 billion in merger costs, the suit alleges, reducing Microsoft's willingness to boost its offer beyond it final verbal offer of $33 made in early May to Yang. The plaintiffs seek to unwind the plan in the hopes of enticing Microsoft back to negotiate a full-scale merger.

Yahoo defended its severance plan, saying it was the right thing for employees and shareholders alike at a time when it needed to keep its employees focused on their jobs.

"We adopted this plan to preserve the company's most valuable asset -- its employees -- at an unprecedented time in the company's history," the Yahoo statement reads.



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