The Arithmetic of the Microsoft-Yahoo Bid

Dan Gross, looking at Yahoo’s share price, says that investors assume the Microsoft-Yahoo deal won’t happen. Which is weird, because Yahoo’s share price has actually been gaining on Microsoft’s bid ever since the announcement was made. I think Gross is wrong, and that a Microsoft takeover of Yahoo is very much priced in to the Yahoo share price. If the deal really did fall apart, Yahoo stock would plunge, quite possibly to below its pre-announcement levels of less than $20 per share.

But that’s all speculation. I know what you really want is arithmetic, so here you go.

On January 31, Yahoo shares closed at $19.18 apiece. The following morning, Microsoft announced its offer to to buy Yahoo for $31 per share, in a half-cash, half-stock deal. By the close of business on February 1, Yahoo stock was at $28.38 per share.

Now this is where things get a little complicated. On January 31, Microsoft shares closed at $32.60. Half of Microsoft’s offer was in the form of $31 per share in cash; the other half was in the form of a swap: each Yahoo share for 0.9509 Microsoft shares. Since 0.9509 times $32.60 is $31, the two halves were equally valuable, and the total value of Microsoft’s offer was $31 per share.

By the close of trade on February 1, however, Microsoft’s stock price had fallen to $30.45 per share. At this point, the stock portion of the bid was worth just $28.95 per share, and the overall bid was therefore worth $29.98 per share. If you look at Yahoo’s share price as a proportion of the value of the bid, then, Yahoo was trading at a 5.4% discount to the value of the Microsoft offer.

Now take a look at where the two stocks are trading today. Microsoft closed at $28.34 per share, which gives its bid a value of $28.97 per share. Meanwhile, Yahoo closed at $29.57 per share. Which means it’s actually trading 2% above the level of the Microsoft offer.

When a target company is trading above the level of the hostile offer which has been made for it, you can assume that investors think the deal is going to happen – and, what’s more, happen at a premium to the initial bid. It’s simple arithmetic.

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