Yahoo now faces more pressure, hedge funds say

NEW YORK (Reuters) - Officially, a potential $47.5 billion deal for Microsoft Corp (MSFT.O) to buy Yahoo Inc (YHOO.O) is over, at least for now.

But longer term, hedge fund managers and analysts said the Yahoo board now faces more pressure than ever to deliver shareholder value in the wake of the collapsed deal and could be forced to reopen merger talks with the software maker.

"This board is toast with a capital T," said Herb Denton, a veteran shareholder activist and head of Providence Capital. "They managed to leave $14.5 billion on the table. Name one shareholder that can be pleased with this outcome, other than the insiders."

Yahoo shares fell more than 15 percent in the last two days after Yahoo and Microsoft disclosed that they had finally ended talks. The subsequent disclosure of a Yahoo-Google advertising deal failed to reverse the Yahoo decline built up over the last few months since Microsoft initiated talks.

With Microsoft out of the picture, at least for now, the big question is how much support billionaire investor Carl Icahn will garner for his proxy campaign to replace the Yahoo board and what effect it would have should he win.

Few expect the veteran activist to end the campaign, since Icahn regularly touts his tenacity in such battles. In addition, he has won significant support from other major hedge funds and stockholders, including Paulson & Co., Boone Pickens' BP Capital, Dan Loeb's Third Point LLC and others.

"This is the worst of all possible outcomes in the near term for Icahn," said the manager of one multibillion-dollar activist fund who asked not to be named. "But everything says he is going to march forward with the proxy campaign."

The investor, who holds Microsoft but not Yahoo shares, said he believes that "this is a game of cat and mouse" and that Microsoft will eventually rebid to acquire Yahoo, particularly if Icahn wins the proxy battle and replaces Yahoo CEO Jerry Yang, as he has said he would do.

"I think this has gotten personal between (Microsoft CEO Steve) Ballmer and Yang," he said.

DEAL RATIONALE REMAINS

Others said the strategic rationale for Microsoft to acquire Yahoo hasn't changed. The software giant needs a bigger Web presence, particularly since rival Google (GOOG.O) is marketing its own versions of commonly used software documents through its website.

"I don't see what has changed since that offer was made in terms of Microsoft's need for that asset," said Benjamin Schachter, a UBS Internet analyst. "So at some point we do think Microsoft will acquire Yahoo."

Icahn, who holds a 4.2 percent Yahoo stake in shares and options, hinted publicly this week that he may hold Yahoo board members "personally liable" in the wake of the failed deal and subsequent share fall. But one corporate lawyer was skeptical that legal action would achieve anything.

"It's tough for a director to say they are doing what is best for shareholders when they leave a significant amount of money on the table," said Jay Gould, partner in Pillsbury Winthrop Shaw Pittman LLP.

"But it's really difficult to find 'breach of fiduciary duty' on the grounds that a profitable deal fell apart. There could be any number of legitimate reasons for ending talks."

Others said Microsoft won't ever come back and that it is now up to Yahoo generate value on a stand-alone basis.

"The board is now under pressure to do something and may consider a stock repurchase," said another activist hedge fund manager. "But I don't think Microsoft is interested anymore."

Others said Icahn's support is evaporating, since he is backed more by speculators seeking a quick sale to Microsoft. Now that the fast-money crowd is probably selling, longer-term investors will have to decide which board slate is most capable of building value without a sale.

"This (Icahn) slate was more intended to achieve a friendly and smooth transaction with Microsoft to deliver them on a platter," said Canaccord Adams analyst Colin Gillis. "If you're a fundamental investor, we don't see much incentive to vote for this alternate slate."

(Reporting by Dane Hamilton and Michele Gershberg; Editing by Gary Hill)