Professor Bainbridge...on law, politics, religion, culture & food

Using a strategic partnership as a poison pill

If you believe Steve Ballmer’s letter to Jerry Yang withdrawing Microsoft’s offer to buy Yahoo, the latter’s threat to outsource search to Google deterred Microsoft from going hostile:

We regard with particular concern your apparent planning to respond to a “hostile” bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo! today. In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo! undesirable to us for a number of reasons:

* First, it would fundamentally undermine Yahoo!’s own strategy and long-term viability by encouraging advertisers to use Google as opposed to your Panama paid search system. This would also fragment your search advertising and display advertising strategies and the ecosystem surrounding them. This would undermine the reliance on your display advertising business to fuel future growth.

* Given this, it would impair Yahoo’s ability to retain the talented engineers working on advertising systems that are important to our interest in a combination of our companies.

* In addition, it would raise a host of regulatory and legal problems that no acquirer, including Microsoft, would want to inherit. Among other things, this would consolidate market share with the already-dominant paid search provider in a manner that would reduce competition and choice in the marketplace.

* This would also effectively enable Google to set the prices for key search terms on both their and your search platforms and, in the process, raise prices charged to advertisers on Yahoo. In addition to whatever resulting legal problems, this seems unwise from a business perspective unless in fact one simply wishes to use this as a vehicle to exit the paid search business in favor of Google.

* It could foreclose any chance of a combination with any other search provider that is not already relying on Google’s search services.

Accordingly, your apparent plan to pursue such an arrangement in the event of a proxy contest or exchange offer leads me to the firm decision not to pursue such a path. Instead, I hereby formally withdraw Microsoft’s proposal to acquire Yahoo!.

It’s an interesting example of using strategic partnership as a takeover defense. One wonders how the Delaware courts would have analyzed the case if Microsoft had sued to block Yahoo from taking such a step. Presumably Unocal would have been the standard of review rather than either Blasius or the business judgment rule. To be sure, Panter v. Marshall Field, held that, absent proof of bad faith or self-dealing, the business judgment rule protects defensive acquisitions by board of directors. Plus, Panter was cited with approval by the Delaware Supreme Court in Moran. Yet, I still think that today the court would apply Unocal.

Although the Delaware Supreme Court held in Time that a board need not abandon its long-term business plan just because a hostile bid has been made, it’s not at all clear to me that Yahoo’s effort to outsource search would qualify as such a plan for purposes of an Unocal analysis. Yahoo would have to show that it was a pre-existing part of a long-term strategic plan.

Moreover, note Ballmer’s observation that the deal with Google would “raise a host of regulatory and legal problems that no acquirer, including Microsoft, would want to inherit.” One can almost hear the wings of Unitrin’s prohibition of preclusive defenses beating in the air.

Thoughts?

Update: Over on my punditry blog, I speculate a bit about how Yahoo and Microsoft shareholders will react.