Trading the Microsoft/Yahoo! Buyout Showdown

The Players

Microsoft put forth an offer to buy Yahoo! for $44.6 billion or a 62% premium over the closing price on Jan 31. Yahoo! formally declined the deal today. Google denounced the merger and later appeared to have offered a deal in which Google would take over Yahoo!’s search function in exchange for some revenue sharing and perhaps guaranteed payments like their deal with MySpace.

What’s at Stake?

A Microsoft/Yahoo! combination would combine their search market share, but would still lag Google’s. The combination would yield a 31.7% market share still behind Google, but not as far behind.

Microsoft has not managed to pickup much steam in its online efforts. As a result they are ready to buy it.

What’s the Trade?

Yahoo!

This could be risky. If Microsoft doesn’t step up with a higher offer either friendly or hostile then Yahoo! stock will tank back to the $20 level and perhaps lower. On the other hand Microsoft is very determined. A potential higher bid could give some short-term gains.

Microsoft

This buyout would drain Microsoft’s cash, but they have plenty of cash cows to replenish their stash. Microsoft from a valuation point is already cheap. This deal would be a difficult one to digest. Buy out Yahoo and have all the talent jump ship and you’ve got a marriage of 2 dogs.

Google

Google received a harsh reaction after news that Microsoft and Yahoo might hook up. Google shares will be under pressure because its earnings came up short of the consensus and now because its two key rivals may get together. In my opinion Google may actually benefit as the MS/Yahoo combo would have a difficult time integrating, would lose much talent, and could lose further market share as they try to regain their footing against Google.

I’m Buying

Google and Yahoo for short-term trades.

First let’s look at Google. I’ve been watching for some time for an entry point and I think this is it. The turbulence with Microsoft/Yahoo will only help Google as it is laser-focused on search. I believe Google is right at an inflection and will snap back to its 3 year trend line at around the $550 mark and higher. Tomorrow I’ll be looking at buying June 21 $600 calls @ $20.25. I’m targeting a 1 month gain of 30-50% on this trade.

Towards the end of trading today I picked up some Yahoo! April $30 Calls at $2.35. I’m targeting a 1 week trade with a gain of 25%.

MoneyRelations.com has a nice post about buying on rumor and selling on fact in regards to this deal. I recommend you check it out. I have another stock I’m buying on rumor that I’ll post tomorrow. We’ll have a real-world test of the theory.