Why Microsoft Should NOT Up its Bid for Yahoo!

Yahoo! is an acronym, it stands for "Yet Another Hierarchical Officious Oracle."

How apt a description of the questionable handling of Microsoft's offer by Yahoo! chief executive Jerry Yang and company. Yahoo! bailed when Microsoft wouldn't meet its demand to increase the bid to $37 a share, saying the offer undervalued Yahoo!

Here's what gets me. Being an accounting geek, I like digging around in the footnotes. I found a time-bomb in Yahoo!'s profits that has flown under the radar screen. Here's why Microsoft, I personally think, was being generous in offering Yahoo! even $31 a share, much less the $33 it hiked the offer to.

If Microsoft eventually does offer a higher bid, that bid should be considered a generous premium for Yahoo!'s 21% share of Internet searches.

As comedian Henny Youngman used to say, "Nem di gelt," Jerry. That's Yiddish for take the money.

Key here is Yahoo!'s 39% stake in Alibaba, the Internet commerce company based in China. Yahoo! bought its 39% stake in Alibaba in 2005. The deal agreement gave Alibaba the right to buy back Yahoo!'s stake if the Internet giant were to be taken over, in order to preserve its management independence, according to a filing with the Securities and Exchange Commission.

The Chinese company had planned to exercise its right to buy back Yahoo!'s investment in its company if Microsoft bought Yahoo, reports indicate.

Check this out--if Microsoft successfully bought Yahoo!, and Alibaba then yanked back Yahoo!'s stake in it, Yahoo!'s profits would have seen a gigantic hole blown wide open in its profits.

Last quarter Yahoo!'s Alibaba stake yielded Yahoo! colossal paper gains of $401m, a stunning 74% of its $542m in reported net income and more than 90% of its operating income, as Yahoo!'s operating expenses climbed inexorably higher toward the $1b level for the quarter, $941.9m, slamming its profits.

US companies are allowed to book in their profits any paper investment gains they earn from investing in other businesses, according to US accounting rules.

But Jerry Yang and company bailed after Microsoft's Steve Ballmer refused to increase the bid to $37 a share. Ballmer was being generous. The last time Yahoo! saw its shares trade at $37 was in January 2006. Check this out--Yahoo!'s shares last hit that stock price of $37 within months of Yahoo! buying its 39% stake in Alibaba.

So Yang and company are more than covering their bases here, knowing that Yahoo! would lose a sizable chunk of its profits if it pursued a merger and Alibaba yanked back its shares. Somewhat grasping, no?

"Yahoo!'s management is delusional, they are living in their past glory," says Charles Payne, founder of Wall Street Strategies (wstreet.com) and Fox Business contributor. "In Wall Street terminology, Yahoo!'s management is tripping."

Maybe Yahoo!'s Yang could fill that profit hole if Alibaba bailed. Yang claims he can now deliver net revenue growth of 25% annually, double the current pace. Really Jerry?