Outside the Lines

Carl Icahn has apparently decided that his 4.98 percent stake in Yahoo common stock is safe in the hands of Yahoo's current eight-member board, which has fought him for control of the company over the last several months. Yahoo co-founder and CEO Jerry Yang lives to fight another day.

Icahn and two other board nominees of his choice will round out the board, keeping current Chairman Roy Bostock and Yang in place. Icahn had proposed a complete board replacement, with Lucian A. Bebchuk, Frank J. Biondi Jr., John H. Chapple, Mark Cuban, Adam Dell, Keith A. Meister, Edward H. Meyer, and Brian S. Posner as his candidates. He has also called for Yang's ouster.

The contentious Mr. Icahn said in a statement:

"I am very pleased that this settlement will allow me to work in partnership with Yahoo's board and management team to help the company achieve its full potential. While I continue to believe that the sale of the whole company or the sale of its search business in the right transaction must be given full consideration, I share the view that Yahoo's valuable collection of assets positions it well to continue expanding its online leadership and enhancing returns to stockholders. I believe this is a good outcome and that we will have a strong working relationship going forward. Additionally, I am happy that the board has agreed in the settlement agreement that any meaningful transaction, including the strategy in dealing with that transaction, will be fully discussed with the entire board before any final decision is made."

If Icahn was so adamant about ousting Yang from the CEO spot and doing a deal with Microsoft, what softened his stance? Following are a few suggestions:

On June 27, Microsoft Chairman Bill Gates said he didn't think that his company and Yahoo would make a deal, adding that Microsoft CEO Steve Ballmer will find "plenty of other opportunities.

Not so fast. As Yahoo's quarterly earnings come up on July 22 (see Kara Swisher's take on the upcoming financial results) and the shareholder meeting on August 1, Carl Icahn and Steve Ballmer are teaming up to remake Yahoo's board of directors and shelve Yahoo CEO Jerry Yang. In a letter to Yahoo shareholders, Icahn said:

Steve (Ballmer) made it clear to me that if a new board were elected, he would be interested in discussing a major transaction with Yahoo, such as either a transaction to purchase the 'Search' function, with large financial guarantees or, in the alternative, purchasing the whole company."

Microsoft issued a letter today confirming Icahn's remarks about Microsoft's renewed interest in a transaction with Yahoo:

While, of course, there can be no assurance of a future transaction, we will be prepared to enter into discussions immediately after Yahoo's shareholder meeting, if a new board is elected.

Now the fate of Yahoo is clearly in the hands of shareholders. They can give Icahn a few seats on the board but not enough control to force massive changes or they can hand over the company to him and Microsoft, knowing that a transaction for $33 to $35 per share for the search business or the entire company will be consummated over the next six months.

As I have said before, Microhoo has always been about the money, and less about a shared strategy and cultural fit. Yahoo's board thought that Yahoo was worth $37 per share, and Microsoft wasn't going to negotiate against itself, with no other buyers in sight.

During an interview at the D6 conference, Yang said:

I understand the situation people are feeling, but at the same time we did not walk away from that proposal, Microsoft did. We are willing to do a deal under the right terms. It wasn't clear to me they wanted to finish the deal. I can't go revisit and take or not take it. I understand our obligation to stockholders from conversations with a number of them. The focus for us is how do we recognize more value for the company soon and position Yahoo to be much more successful in the long term. If there is a way to do it, we'll talk about other alternatives, but we aren't going to do something short term.

Yang has some regrets that Microsoft walked away from negotiations in May. He may prefer an independent Yahoo, but reality is setting in, and now he is probably wishing he and his board had played less difficult to get.

Update: Yahoo issued a testy statement regarding the Icahn-Ballmer "apparent effort to force Yahoo! into selling to Microsoft its Search business at a price to be determined in a future 'negotiation' between Mr. Icahn's directors and Microsoft's management."

In the statement, Yahoo invited Microsoft to make a proposal immediately and for Icahn to reveal his plan for Yahoo beyond teeing up Microsoft to make a deal. I doubt Jerry Yang and company are going to receive any kind of proposal until the shuffle at the upcoming shareholder meeting takes place.

As expected (see previous reports), Microsoft scooped up Powerset to buttress its search efforts.

Barney Pell, Powerset co-founder and CTO

(Credit: Dan Farber)

It's not a replacement for increasing market share by acquiring Yahoo Search, but it gives Microsoft some differentiated search technology and top engineers for less than $100 million. Ramez Naam, group program manager of Live Search, said the Powersoft negotiations happened in parallel with the Yahoo talks over the last few months. Google and Yahoo may also have been interested in Powerset, but no one is talking.

Whether Microsoft can leapfrog Google over the long term with this semantic engine remains to be seen.

Powerset had done a good job of creating a rich semantic layer on top of Wikipedia, but bringing natural language and slick semantic-based interfaces to the entire Web is a long-term and very costly endeavor.

"With an existing search infrastructure, incredible capital resources, unlimited data, a leading search team, and clear mission to revolutionize the search landscape, Microsoft can rapidly accelerate our progress in building semantic search technology and bringing it to full Web scale," Powerset's Mark Johnson said in a blog post about the acquisition.

Powerset can provide direct answers to queries from its Wikipedia and Freebase index and highlight the most relevant search results based on the meaning of the query.

According to a blog post from Satya Nadella, Microsoft's senior vice president of Search, Portal, and Advertising, Powerset's engineers will join the Search Relevance team and remain in San Francisco.

Back to the leapfrogging Google question. Much of what Powerset has enabled with its technology is a superior user experience for searching. Powerset's Wikipedia search, which surfaces concepts, meanings, and relationships (like subject, verbs, and objects in a language), is the very small tip of the iceberg.

If Microsoft can succeed in extending Powerset's technology to key parts of the Web corpus, Google will have to figure out a way to match the quality and user experience. And, there is little doubt that if Google decided that what Powerset and Microsoft are doing as one is important, the company dedicated to dominating search through its engineering prowess will circle the wagons.

A few months ago, Powerset co-founder and CTO Barney Pell told me that his start-up company's software was a first step in changing the way users search and consume Web content. "It's a complete shift. You see this and you want to experience all content in this way. And, as an introduction, it will drive huge investment in semantic and linguistic technology, just as investments were made in information retrieval and scalable databases in the past," he said.

During a conversation after the announcement, Pell told me, "Natural language search will be the center of innovation for the next 20 years." It will likely take 20 years to engineer the semantic, natural language Web that Tim Berners-Lee envisioned in his 2001 essay in Scientific American.

Joe Nocera gives Yahoo CEO Jerry Yang a very public drubbing in his New York Times column, accusing him of shirking his fiduciary responsibilities to shareholders.

Nocera, who writes about financial issues for the paper, concluded:

A takeover by Microsoft was your last, best hope of rewarding your long-suffering shareholders. Now that opportunity is gone. It says here Mr. Icahn is not going to go as gently into the night as Mr. Ballmer did -- and if I were a betting man, I would be taking odds that your days as Yahoo's C.E.O. are numbered.

It'll be better for everyone to have someone in that role who understands who he's supposed to be working for. Wouldn't you agree?

As I wrote Saturday, Yang and his No. 2, Sue Decker, are on a short leash, and will very soon have to explain and show how they are going create shareholder value above what a Microsoft marriage would have delivered. Yang and Decker might be on the right track with the changes underway, but they are now working in a negatively charged environment, with pundits and shareholders lobbing bombs into Yahoo's board room.

Yahoo board Chairman Roy Bostock

(Credit: Duke University)

While Yang is taking the brunt of the criticism, Yahoo's board of directors, led by executive Chairman Roy Bostock, pulled the strings that led to Yahoo's miscalculation in handling Microsoft's bid to acquire the company. It was just about the money. Forget about Yang's bleeding purple, founder's desire to stay independent and antipathy toward Microsoft. For $37 per share Yahoo's board, or less, was willing to sell out. Microsoft's desire for a union faded as Yahoo's board played hard to get, and eventually Gates and Ballmer soured on the whole deal.

Corporate raider Carl Icahn is hoping to bounce the board in the upcoming proxy battle at the annual shareholder meeting on August 1, but that's not likely to bring Microsoft back to the negotiating table.

Yahoo is not on its last legs or unable to articulate a business plan. It's a profitable company with huge assets, but it's hard to look great compared with Google. The messaging has gotten out of Yahoo's control, which has put Yang and company in a perpetual defensive mode.

Speculation is starting about who might be the next CEO of the company if the founder is bounced. It will be someone from the outside who has loads of experience and credibility in running an large media and technology company. And many of the current board of directors will have gone on to other things.

With the Microsoft/Yahoo/Google triangle taking a new shape as Microsoft exited and Yahoo and Google connected, the analysts covering tech industry sports are weighing in with their opinions.

Some Wall Street analysts believe Microsoft will take another run at Yahoo if the company can't get back on track or Carl Icahn wins his proxy fight to control the Yahoo board. That may be wishful thinking. Kara Swisher reports that Microsoft is done with its courtship of Yahoo and nothing will bring them back to the negotiating table.

Mike Arrington of TechCrunch called the Yahoo-Google deal a massive destruction of shareholder value, employee morale, and the Interent balance of power:

Yahoo's hatred of Microsoft runs so deep that they were actually, in the end, willing to destroy the future of their company just to keep it independent for a short while longer. They've ignored the wishes of their shareholders, employees and many now former key employees in killing that deal. And apart from Google, CEO Jerry Yang, President Sue Decker and possibly Tim O'Reilly, I don't believe there is anyone in the world that is happy with what has happened.

In a further lambasting post, Arrington called Yahoo desperate and possibly neurotic:

Quite simply, it looks to me like Yahoo is effectively paying Google off to step in and (1) keep Jerry Yang, Sue Decker and the current board of directors in power, and (2) avoid a desperation deal with Microsoft for as long as possible, or longer. It's not even clear to me that Google wants this deal, based on the terms. It almost looks like they're just doing Yahoo a favor, and trying to keep them out of Microsoft's hands.

At the other end of the spectrum, venture capitalist Fred Wilson thinks that Yahoo did the right thing by choosing Google over Microsoft as a partner.

Yahoo! finally woke up and did what they should have done years ago, cede search monetization to Google who simply does it better and will always do this era of search better than anyone else.

Now Yahoo! will do what it needs to do. Clean house, get lean, get out of businesses it shouldn't be in. Focus on what it's good at. And start making money and growing again.

They may need new leadership to do that. But selling this asset to Microsoft just because they had the wrong leadership and probably still have the wrong leadership is a mistake.

From my reading of the events over the last five months, Yang regrets that Microsoft walked away from the acquisition talks. "We all felt and understood a combination done right has a tremendous amount of power and leverage," Yang said during an interview with Walt Mossberg at the D6 conference.

Yahoo CEO Jerry Yang and President Sue Decker have a challenging set of quarters coming up.

(Credit: Dan Farber/CNET News.com)

As a founder, Yang preferred that Yahoo stay independent and that he have the chance to turn the company around as CEO. Microsoft historically was not the kind of partner that Yang considered for a marriage. And his board of directors, led by non-executive Chairman Roy Bostock, seemed to go along with that line of thought.

But the entire affair turned out to be mostly about the money, as Decker admitted. "We never got through the price door," she stated during the same D6 interview. Yahoo's board believed that the company was worth more than $35 per share based on future promise, and Microsoft wasn't on the same page. In effect, Microsoft called Yahoo's bluff.

It also wasn't helpful that Yahoo was negotiating the search deal with Google at the same time Microsoft was pursuing its hostile bid. After months of rejection, Microsoft basically became less enchanted with the potential marriage, and despite the pummeling from the shareholders, Carl Icahn's camp, and the press, Yang and his advisors held out for more money.

Unable to come to terms with Microsoft on a generous deal just for the search business, Yahoo took the less complicated, non-exclusive Google deal that allowed the company to remain in the search game.

As I wrote in my post "The battle for Yahoo's soul," Jerry Yang and Sue Decker have a short runway--about six months--to prove that they can "redefine" the essence of Yahoo in a way that yields more revenue, profit, and positive buzz. With the continuing board room distractions, employee defections, and morale issues that go along with being under siege by various parties, the duo have their work cut out for them.

On this week's EIC Squared podcast, ZDNet's Larry Dignan and I discuss the latest moves in carving up the wireless world as Verizon Wireless announced plans to acquire Alltel for $28.1 billion. It won't be long before the U.S. wireless industry shakes out into AT&T, Verizon, and a Sprint/T-Mobile merger. We also discuss the latest news in the travails of Yahoo as it tries to keep Carl Icahn from taking over the board.

Plus, we speculate about the Steve Jobs' keynote at Apple's Worldwide Developers Conference on Monday.

Yahoo's top two executives came out of their serial and secretive negotiations with Microsoft and Google to shed light on the cloudy future of the company. In an interview Wednesday at D6 with Walt Mossberg, CEO Jerry Yang and President Sue Decker did little to shed light on the negotiations or possible outcomes.

Of course, it wasn't expected that the pair would say anything revealing about the negotiations with Microsoft other than the stock answers Microsoft's Bill Gates and Steve Ballmer gave during their D6 interview Tuesday night.

Yang mostly reiterated what has been said in the public letters going back and forth between Microsoft and Yahoo. On the current state of negotiations, Yang said, "As companies are positioned we have to understand more of what they are proposing to us. We are doing our best to understand Microsoft's interest."

Yang gave indications that he regretted Microsoft's decision to walk away from the negotiating table during the acquisition talks.

"It's like a high school breakup--he says, she says," Yang said. "It's not constructive to go back (over what happened)...I'm mixed about what happened. We all felt and understood a combination done right has a tremendous amount of power and leverage." He also said that there wasn't a single defining reason that caused the the two companies not to reach an agreement.

Decker was more straightforward: "We never got through the price door," she stated.

Walt Mossberg grills Yahoo's Jerry Yang and Sue Decker.

(Credit: Dan Farber/CNET News.com)

Yang: Yahoo is not under siege
Yang maintained that Yahoo is well positioned for the future as an independent company, and not getting weak and vulnerable. "The perception of us being a company under siege is just not accurate," he said. "The process has in many ways pulled together Yahoo as a company. It's a real life exercise of crisis management. What we do matters. I think in a way that's what the morale and culture at Yahoo is all about." He added that Yahoo can continue to build great products and move forward and is more ready for the challenges ahead than last year. "The essence of yahoo is being redefined today and making us stronger," he said.

Mossberg probed further, asking why Yahoo rejected the $33 per share offer from Microsoft.

"I understand the situation people are feeling, but at the same time we did not walk away from that proposal, Microsoft did," Yang said. "We are willing to do a deal under the right terms. It wasn't clear to me they wanted to finish the deal. I can't go revisit and take or not take it. I understand our obligation to stockholders from conversations with a number of them. The focus for us is how do we recognize more value for the company soon and position Yahoo to be much more successful in the long term. If there is a way to do it, we'll talk about other alternatives, but we aren't going to do something short term."

Decker added some color on how the business was valued by Yahoo's board. She said that Yahoo has a huge inventory created by 500 million to 600 million users per month. "We think the inventory is undervalued in search," she said, saying that Yahoo's Panama ad system is closing the price gap with Google and that 90 percent of inventory is not search-related.

What is Yahoo's business?
Mossberg asked Yang how he defined Yahoo's business. The Yahoo co-founder responded, "I think of Yahoo as we have to be incredibly relevant and useful to users. You have to start your day at Yahoo. We want people to come to Yahoo first thing in the day and multiple times a day. That is an incredibly powerful position, consistent with our roots and ripe for innovation."

Yang came up with a shorter elevator pitch after his more lengthy opening statement: "The starting point for people to get the most out of the Web is our dream and aspiration." He later said, "If (you) look at that base of people (500 million Yahoo users per month), we need to be relevant to those people as they grow up on the Web."

He noted that Yahoo can't be all things to all people, and has to be more focused on how it builds products going forward.

Yahoo's open social strategy
Then Decker chimed in to really get to the heart of what will make Yahoo tick. Yahoo doesn't have a problem in reaching users. It has over half a billion users per month, 250 e-mail users, and 10 billion social connections across mail, instant messaging, Flickr and other Yahoo properties.

She gave a pitch for Yahoo Open Strategy, which will ignite the social graph that is latent within Yahoo, and which is a key to the future of Yahoo.

The first fruits of Yahoo Open Strategy will appear later this year, and will include a development environment for several properties, a social "activator" and graph engine, an events engine, and a single profile for users, according to Yahoo CTO Ari Balogh. The activator engine handles the combining of different relationship groupings, such as the Yahoo Mail e-mail address book, Yahoo Messenger contacts, Flickr friends, Yahoo 360, and Yahoo Mash.

The Google question
Regarding the controversial deal in which Google would sell ads on Yahoo, Yang said, "In the last public statement we said we conducted a test with them and have an understanding of what they can do for us and what we can do for them. It could be a unique arrangement, but we haven't talked about it. Yahoo has the ability to remain very competitive in the advertising space and the flexibility to partner with Google, but that has not been understood in the marketplace. Until we get to something to talk about, it's all speculation."

Mossberg noted that Google is continuing to gain search share. The search game is pretty early, Yang said, especially the aspect of social search, people passing around and sharing search information. Yahoo will differentiate its search, Yang seemed to say, by leveraging its 500 million user base.

Yang: I am the best person to lead Yahoo
Kara Swisher asked why Yang and Decker should be in their respective positions given the performance of the company over the last few years. Decker responded, "As a company we have made a few mistakes, and Jerry and I are excited to try to address them." She admitted that Yahoo lost touch with users somewhat as it pursued more of an applications strategy. "We lost the core focus around the core ecosystem of users, advertisers and publishers."

Yang also responded: "I am a co-founder and involved in company the whole time and probably not CEO of another company unless I start another company. I do think I am the best person to lead Yahoo...not only because I bleed purple, bleed Yahoo...there is a big opportunity for Yahoo to fulfill. It's my time to take Yahoo to the next level, that allows our audience to do what they can't do anywhere else except on Yahoo." He concluded that he and Decker are starting to show that Yahoo can be on a "path to being a very different entity."

The summary
Yang and Decker have a strategy--the Yahoo open and social strategy--but they are still in crisis management mode and under stress to resolve uncertainty around the future of the company as it relates to Google, Yahoo, and shareholders. It could be a long and frustrating summer as the continuing saga unwinds. Most importantly, Yahoo has to execute on its rewiring of its services and new display advertising solution. Without those pieces, the value of Yahoo will be in decline, and the $33 per share Microsoft offer will be looked upon as a major error in judgment by Yahoo's board.

The Yahoo video
Prior to the interview, Yahoo showed a humorous video, following a tradition of Microsoft at industry events.

Legendary investor Warren Buffet let Decker in a on little secret. Buy low, sell high. Venture capitalist Mike Moritz said Yang and his co-founder David Filo should go back to Stanford. Charley Rose told Yang he should dress in earth tones and lose the glasses to close the deal, so to speak. Sony CEO Howard Stringer suggested that Yang get into electronics. Intel CEO Paul Otellini gave Decker ideas for marketing herself, such as a musical theme, and Michael Dell told Yang how best to deal with Mossberg in interviews. Cisco Systems chief John Chambers was selling Yang on his $300,000 Telepresence product. Mark Zuckerberg said he should sell 1.6 percent of his company to Microsoft. At the end, Microsoft was called...

Click here for full coverage of the D: All Things Digital conference.

Continuing the exegesis of Steve Ballmer's remarks on how Yahoo should be viewed as part of "a" strategy to accelerate Microsoft's online advertising, but not "the" strategy, CNET News.com Executive Editor Jim Kerstetter and I attempt to make sense of the latest twists and turns in the Microhoo saga. Watch the video:

See also:

What Ballmer really meant to say in Moscow

Ballmer is trying to rewrite Microhoo history

While speaking in Moscow, Microsoft CEO and Yahoo suitor Steve Ballmer said, "Yahoo was never the strategy we were pursuing, it was a way to accelerate our online advertising business...We will spend money on some acquisitions. You can do a whole lot of things with 50 billion dollars."

In support of Ballmer's recent remarks, Microsoft officials maintain that Yahoo has always been part of "a" strategy, and not "the" strategy.

Yahoo is a means to an end. Of course, Microsoft was primarily interested in the search piece, but they apparently thought that acquiring the rest of Yahoo would also have some strategic value. Otherwise, why pay so much, unless Microsoft thought it couldn't achieve what it wanted without making an offer for the entire company.

In my post analyzing Ballmer's Moscow remarks, I said that he was doing a bit of historical revisionism. The initial $31 per share, $44.6 billion, a 62 percent premium on the January 31, 2008 price was for more than just getting access to Yahoo search technology, engineers, and contracts.

Now, after 113 days of going back and forth, Ballmer and his team have refined the overall strategy to focus on Yahoo's search business. It was apparently Yahoo CEO Jerry Yang who brought up the idea of Microsoft doing a deal around search at a meeting prior to Microsoft walking away from the negotiations on May 3. At the same time he dangled search in front of Microsoft, Yang was also talking to Google about a search-related partnership.

It appeared from Ballmer's letter to Yang on May 3 outlining the reasons he was taking a $33 per share offer off the table, that Yahoo's negotiation with Google for a search deal was a major pain point that drove Microsoft away.

Microsoft and Yahoo have reengaged negotiations on a search deal, and Microsoft is also reserving the right to reconsider a full acquisition "depending on future developments and discussions that may take place with Yahoo or discussions with shareholders of Yahoo or Microsoft or with other third parties," according to a Microsoft statement from May 18. I guess that is part of "a" strategy, but it's "the" strategy of accelerating the online advertising business.

In other words, it still might be strategic to acquire all of Yahoo (given acquisitions are supposed to be strategic), but the predominant strategy is to blunt Google's search offensive with Yahoo search as an accelerant.

In effect, Microsoft has three possible avenues to take in its strategy: acquire all of Yahoo; acquire or joint venture on Yahoo search; or find another alternative (there aren't many left) to accelerate its online fortunes. At this point, Microsoft may no longer find it strategic to acquire all of Yahoo.

Yahoo could do a search deal with Google, which might never get done due to regulatory scrutiny and would make large shareholders unhappy, or do a deal with Microsoft. The odds favor some kind of Yahoo-Microsoft transaction.

Tune in next week for the next chapter in this saga. On Tuesday at the D: All things Digital conference, hosted by The Wall Street Journal's Walt Mossberg and Kara Swisher, the main actors will be in the same room. Bill Gates, Ballmer, Yang, and Yahoo President Sue Decker will be in attendance. The crowd will be looking for any contact or body language that could signal whether the two parties have found strategic alignment.