Yahoo and Icahn settle; Microsoft deal seen adrift

By Michele Gershberg and Tiffany Wu

NEW YORK (Reuters) - Yahoo Inc will appoint activist investor Carl Icahn and two of his nominees to its board, defusing a proxy battle showdown and making an immediate deal with Microsoft Corp less likely.

The settlement with Icahn, announced on Monday, came just 11 days before Yahoo's August 1 annual shareholders meeting. Icahn had originally sought to replace the entire board with his own nominees and oust Yahoo Chief Executive Jerry Yang.

But Icahn's campaign appeared to have failed to win backing from key shareholders such as Legg Mason fund manager Bill Miller, who said on Friday he would support Yahoo's board. Legg Mason owned 4.4 percent of Yahoo, according to recent filings.

Icahn failed to convince many investors that if he had won control of Yahoo at the upcoming annual meeting, that he had any alternative for turning the business around, other than to sell it in part or in whole to Microsoft.

"It may be possible it does generate some positive change. Perhaps Icahn can drive some more staff reductions, persuade it to divest its Asia investments," Jeffrey Lindsay, an analyst at Sanford C. Bernstein, said of the settlement.

"Overall it seems much less likely that there will be a transaction with Microsoft. The market is already reading it that way," he added. "This looks like a compromise and in general most of these compromises, certainly with ones with Icahn in the past, have reinforced the status quo."

A Microsoft spokesman declined to comment on its next move, but the company will no doubt face questions about its Internet strategy at its annual analyst meeting on Thursday.

Yahoo has said Microsoft's various deal proposals have undervalued its business and instead reached a search advertising partnership with arch rival Google Inc to boost its performance.

Yahoo shares fell 78 cents, or 3.5 percent, to $21.67, far below Microsoft's last offer price of $33 per share, which was withdrawn in May. Microsoft shares lost 22 cents to $25.64.

A REPRIEVE FOR MANAGEMENT

After six months of on-again, off-again talks with Microsoft that have undermined Yang and his management team's credibility with Wall Street, the settlement with Icahn could shore up Yahoo's position in the near term.

"Yahoo's current management is much better suited for Yahoo shareholders throughout this transition period. It's not like a vote of confidence, it's just they're the right people to get us through the disaster that we're in," said RBC Capital Markets analyst Ross Sandler.

"They've done a poor job, but unfortunately there isn't a whole lineup of really good Internet executives who are pounding down the door to take on this challenge."

Yahoo reports quarterly results on Tuesday and some analysts said the Icahn settlement could help allay pressure over what is expected to be a weak second-quarter performance.

"They may be able to find a few extra pennies this quarter via cost controls just to show the market that they are making improvements," Canaccord Adams analyst Colin Gillis said.