Why Carl Icahn May Fail at Yahoo!

Billionaire investor Carl Icahn has assembled his dream team of a new slate of directors to replace Yahoo's entire board, after Jerry Yang and his cadre at the Internet giant punted on Microsoft's sweet offer to buy the company.

But a dream team of new directors won't be enough. Icahn faces an uphill battle doing what he thinks needs to be done by knocking some sense into Yahoo! at the company's annual meeting on July 3, a meeting which could prove to be chaotic. At that meeting, shareholders can vote against board members, including Yahoo! chief executive Jerry Yang. All 10 directors are up for reelection.

Here's a cheat sheet to use while following this Silicon Valley battle royale and to see what Icahn is up against:

*Corporate governance rules at Yahoo! dictate that a director must resign if a majority votes against that person. However, Yahoo's board gets to ultimately decide whether to accept or reject a resignation. That's a huge sticking point.

*Yahoo! has a poison pill anti-takeover defense that says all of its board members, not just three or four, must be replaced in the event of a hostile takeover.

*Icahn has not succeeded in prior fights with company boards. Motorola reached a truce with Icahn, agreeing to nominate just two of his picks for its board in exchange for Icahn's agreement to end his proxy battle for four seats.

*Biotech company Biogen Idec recently nominated its own slate of directors for its board, shunning the nominees brought forth by Icahn and marking the likely beginning of a proxy fight.

*Analysts say a "vote-no" campaign run by an investor activist would succeed more than an activist launching a proxy battle. It's cheaper than running a proxy campaign, which costs several million dollars in solicitation and legal fees.

*The big unknown: Whether Microsoft still stays away even if Icahn succeeds.

All this doesn't mean all is well on the Yahoo! side of the aisle. Yahoo-Yang yesterday fought back with a letter saying Icahn's take on the matter represents a "significant misunderstanding" of its efforts.

Its defense: It met a lot to discuss the offer. Yahoo's board has met 20 times in recent months to consider options, including Microsoft's bid. The top managers of Yahoo and Microsoft met face-to-face seven times, the letter said.

Wow. Is that enough to defend themselves against any suits alleging breach of fiduciary duty?

No one in their right mind, separate from Yahoo!'s top managers and its board, thinks Yahoo! is worth more than the Microsoft bid. Just check out its last quarter--a stunning 74% of its $542 million in reported net income and more than 90% of its operating income came from, get this, paper gains in an investment Yahoo! made, not from its own operations. See my prior blog Why Microsoft Should NOT Up its Bid for Yahoo!

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 $401 million, a stunning 74% of its $542 million 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. Which is likely the reason why no other company is stepping forward with an offer for Yahoo!

Watch the stock sail back toward $20 if Icahn fails and Microsoft stays away.