Yahoo Owners May Prefer Microsoft Bid to Google Fight

 (Bloomberg) -- Jerry Yang, who pledged last year to lead his team of ``Yahoos'' to victory, may find investors would rather team up with Microsoft Corp.

Yahoo! Inc. rose the most since its first day of trading when Microsoft offered $44.6 billion for the company, the second-most popular search engine, on Feb. 1. Yang, who returned as Yahoo's chief executive officer to try to reverse a two-year stock slump, had presided over a 32 percent drop before the bid.

Microsoft said Yahoo executives snubbed its overtures last year in favor of tackling Internet search leader Google Inc. independently. Yahoo's stock performance shows investors don't embrace that strategy and that Yang's promises to revamp the company's search engine and gain on Google were in vain.

``It's hard to look shareholders in the eye and say it doesn't make sense,'' Robert Doll, chief investment officer of global equities at BlackRock Inc. in Princeton, New Jersey, said of Microsoft's unsolicited offer. ``There won't be a whole lot of options for Yahoo.'' He oversees $1.3 trillion in assets, including stock in Microsoft, the world's biggest software maker.

Microsoft's $31-a-share bid came three days after Sunnyvale, California-based Yahoo posted an eighth straight quarter of declining profit and projected sales that trailed most analysts' estimates.

Shares Gain

Yahoo was trading at $19.18 before the offer. The shares rose 48 percent in Nasdaq Stock Market trading on Feb. 1 and advanced 95 cents to $29.33 at 4 p.m. New York time today. Microsoft fell 26 cents to $30.19, while Google dropped $20.47 to $495.43.

Google Chief Executive Officer Eric Schmidt called Yang to suggest a potential partnership between the two companies to thwart Microsoft's bid, the New York Times and the Wall Street Journal reported today, citing people familiar with the matter.

``Yahoo has a lot of options, and you can look at what analysts have said about those options,'' spokeswoman Diana Wong said when asked about the Journal's report. Yahoo said in a statement on Feb. 1 that it will review the offer ``promptly.''

Yang, 39, agreed to take over at Yahoo in June, replacing Terry Semel, after its share of Web searches tumbled and the company lost out on sales of graphics-based ads mainly to social-networking sites like News Corp.'s MySpace and Facebook Inc.

In Semel's six years at the helm, he built Yahoo's online ad business through acquisitions and internal development. While the shares jumped almost sevenfold under his watch, Google's rising dominance led the stock to plunge 35 percent in 2006, and investors began calling for Semel to resign.

Yahoos Rally

``I'm ready to rally our near-12,000 Yahoos around the world,'' Yang said on a conference call when he took over. He planned to foster ``a winning culture, while strengthening our leadership team to galvanize Yahoos around our goals.''

Microsoft's bid came too soon for Yang to prove himself, said Ellen Siminoff, who worked with him at Yahoo for seven years and now leads Mountain View, California-based Efficient Frontier, which helps companies advertise on search engines.

``It's hard to get any sort of change that quickly,'' Siminoff said. ``He would rather sell having fixed the company than sell after a perception of weakness.''

Microsoft chose Yahoo as a partner after repeatedly coming in a distant third in Internet searches and failing to bolster advertising revenue on its own. Yahoo would give Redmond, Washington-based Microsoft the most popular group of Web sites in the U.S., which reach about 500 million people worldwide.

Reviewing the Deal

The U.S. Justice Department is ``interested'' in reviewing the antitrust implications of the deal, agency spokeswoman Gina Talamona said last week. Neelie Kroes, commissioner of competition for the European Commission, said her agency also would scrutinize a Microsoft-Yahoo deal.

The offer ``raises troubling questions'' for Web users, Google said yesterday, questioning whether Microsoft would seek to exert ``inappropriate'' influence over the Internet. Microsoft General Counsel Brad Smith disputed the claims in a statement.

Microsoft and Yahoo explored ways to work together in late 2006 and early 2007, according to a letter by Microsoft CEO Steve Ballmer to the Yahoo board dated Jan. 31. Yahoo rejected the idea of being taken over by Microsoft a year ago, according to Ballmer, 51.

``I doubt that Jerry and David want to sell Yahoo,'' said Mark Cuban, the billionaire owner of basketball's Dallas Mavericks, who sold Broadcast.com to Yahoo in 1999. ``But this is a very smart move for Microsoft. There will surely be a ton of duplication on the technology side, which should cut costs significantly.''

Next Step

The offer from Microsoft is one of many options Yahoo is evaluating, Yang and Chairman Roy Bostock said in a Feb. 1 e- mail to employees obtained by Bloomberg News. The board will respond after reviewing the alternatives, they said. If Yahoo accepts the deal, Yang stands to get about $1.6 billion in cash or Microsoft stock for his 52.8 million shares.

Microsoft may seek to oust Yahoo board members should they reject its offer, said a person familiar with the matter, who asked not to be identified. Under Yahoo's bylaws, stockholders must nominate directors by March 13, ahead of the company's annual meeting, the person said. Microsoft spokesman Frank Shaw declined to comment. Wong didn't immediately return a voicemail message.

Yahoo's advisers, Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc., are approaching other potential bidders in search of a higher offer, the New York Times reported Feb. 2.

 

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Hidden Swap Fees by JPMorgan, Morgan Stanley Hit School Boards

(Bloomberg) -- James Barker saw no way out. In September 2003, the superintendent of the Erie City School District in Pennsylvania watched helplessly as his buildings began to crumble.

The 81-year-old Roosevelt Middle School was on the verge of being condemned. The district was running out of money to buy new textbooks. And the school board had determined that the 100,000-resident community 125 miles north of Pittsburgh couldn't afford a tax increase. Then JPMorgan Chase & Co., the second-largest bank in the U.S., made Barker an offer that seemed too good to be true.

David DiCarlo, an Erie-based JPMorgan Chase banker, told Barker and the school board on Sept. 4, 2003, that all they had to do was sign papers he said would benefit them if interest rates increased in the future, and the bank would give the district $750,000, a transcript of the board meeting shows.

``You have severe building needs; you have serious academic needs,'' Barker, 58, says. ``It's very hard to ignore the fact that the bank says it will give you cash.'' So Barker and the board members agreed to the deal.

What New York-based JPMorgan Chase didn't tell them, the transcript shows, was that the bank would get more in fees than the school district would get in cash: $1 million. The complex deal, which placed taxpayer money at risk, was linked to four variables involving interest rates. Three years later, as interest rate benchmarks went the wrong way for the school district, the Erie board paid $2.9 million to JPMorgan to get out of the deal, which officials now say they didn't understand.

``That was like a sucker punch,'' Barker says. ``It's not about the district and the superintendent. It's about resources being sucked out of the classroom. If it's happening here, it's happening in other places.''

$12 Billion in Deals

It is. During the past four years in Pennsylvania alone, banks have pitched at least 500 deals totaling $12 billion like the one JPMorgan Chase sold to Erie, according to records on file with the state Department of Community and Economic Development. Most of the transactions -- which occurred outside the state's largest cities of Philadelphia and Pittsburgh -- have been made without public bidding, which means that banks and advisers privately arranged the deals with small school districts, the records show.

JPMorgan's Chief Executive Officer Jamie Dimon declined to say if he thought the bank's fee disclosure was proper and whether the bank acted in a fair, responsible and moral manner in Erie.

Banker DiCarlo declined to comment. JPMorgan spokesman Brian Marchiony says the deal gave the school district immediate debt savings and protected it against unpredictable interest rate risk in the future. He declined to answer specific questions.

Overpaying Fees

The Pennsylvania transactions involve interest-rate swaps, which are derivatives. Derivatives are financial contracts whose value is based on other securities or indexes; interest-rate swaps are tied to future changes in lending rates.

The Pennsylvania deals show that school districts routinely lose when making derivative deals. They pay fees to banks that are as much as five times higher than typical rates and overpay advisers by as much as 10-fold. That means banks often underpay schools on upfront amounts, as JPMorgan Chase did in Erie, public records show. And school officials aren't always well served by their supposedly independent advisers, whose fees are paid by the banks selling the deals -- only if the sale is made.

`Getting Fleeced'

In 15 Pennsylvania school districts, officials entered into interest-rate-swap deals worth $28 million since 2003, according to data compiled by Bloomberg. Of that dollar amount, the schools took in $15 million, and banks and advisers got the rest as fees, Bloomberg data show.

``The school districts are getting fleeced,'' Pennsylvania Governor Edward Rendell says. The governor, 64, a Democrat who has been in office since 2003, says the state might in the future advise schools and municipalities on derivatives contracts before they sign with banks. Christopher Cox, chairman of the U.S. Securities and Exchange Commission, says he's concerned that municipalities are taking on more risk than in the past when they raised money primarily from bond sales.

``It's a serious issue, not only in Pennsylvania but across the country,'' says Cox, 55, who has headed the SEC since 2005. ``That is what we have seen repeatedly. More often than not, the municipalities aren't configured to have financial sophisticates in charge of these offerings -- and the result is that the firms are the only ones who know what's going on.''

Just five years ago, municipal derivative deals weren't sanctioned in Pennsylvania, the sixth-most-populous U.S. state. Then, in September 2003, the state Legislature adopted a law allowing schools and towns to use interest-rate swaps to lower borrowing costs and raise cash.

Exchanging Payments

In a swap, two parties agree to exchange payments over a period of time that can last as long as 30 years. Typically, one agrees to pay a fixed rate and the other to pay a variable rate that changes with a benchmark index or formula defined in the contract.

Public agencies can benefit by using derivatives to guard against swings in borrowing costs or to lock in current interest rates for bond sales they might not make for years. In many cases, school districts use swaps as a way to refinance bonds they've issued in the past.

Derivative deals can bring banks fees three times higher than the traditional selling of municipal bonds, public records show. School districts don't know whether they're getting fair market values with swaps because the contracts are private; they don't know how to compare their deals with those done by other districts.

`Profits Are Greater'

This lack of transparency is a boon for the banks, says Christopher ``Kit'' Taylor, executive director from 1978 to 2007 of the Municipal Securities Rulemaking Board, a panel that issues rules on municipal bond sales.

``Business moves from transparent and competitive markets to markets where there is less transparency and the profits are greater,'' he says. ``If you don't know how much you're paying, you're going to be paying too much.''

The Pennsylvania swap law was passed after lobbying by financial advisory firms that stood to profit from such deals.

The legislation made the state a member of an expanding club. Forty states give government bodies explicit authority to make derivative deals, up from none 20 years ago, says David Taub, a lawyer who specializes in derivatives and is a partner at McDermott Will & Emery in New York.

Derivatives aren't regulated by the SEC, the MSRB or by states. Pennsylvania offers a clear look at these deals because, by law, all the contract records must be publicly filed with the state.

Pennsylvania Adviser

One derivative advisory firm that backed the Pennsylvania swaps legislation is Investment Management Advisory Group Inc., or IMAGE. The Pottstown, Pennsylvania-based company was raided by the Federal Bureau of Investigation in November 2006 in connection with a criminal antitrust investigation of bid rigging of investment contracts that are sold to states and municipalities.

The U.S. Justice Department is also probing municipal derivative deals. IMAGE has said it's cooperating with the probe. No charges have been filed.

In some Pennsylvania transactions, banks bought from school districts rights to exercise options on an interest-rate swap, or swaptions. Banks can choose to exercise the option if they stand to make money or can let the option expire if interest rates aren't favorable to them.

Banks Hedge Risk

The banks that arrange these deals create the swap contracts before pitching them to schools. Using software programs designed for valuing swaps, they calculate prices for which they can sell them after a school signs a contract. That's how the banks make money. For example, if a bank agrees to pay a district $800,000 in a deal it valued at $2 million, it could reap $1.2 million for itself and middlemen.

``They load it off instantly,'' says Taylor, who's now on the advisory board of Rockwater Municipal Advisors LLC, an Irvine, California-based investment firm.

Banks hedge their risk in derivative deals by making trades to cover possible losses to school districts. The banks make their money from fees, regardless of interest rate movements.

The reason Erie and other districts don't know how much the bank makes from a deal is because banks don't tell them, the records show. The money isn't paid immediately out of school budgets. Fees are hidden from schools because banks include those costs in the contract by adjusting interest rates up or down.

SEC Disclosure Rules

While the SEC doesn't regulate derivatives, it has authority to oversee how banks conduct transactions. SEC Chairman Cox says all financial firms should tell clients what their fees are before signing any deals.

``Brokers and advisers should disclose their compensation and conflicts of interest to their customers, and to the extent that they are regulated by the SEC, they must,'' he says.

Cox also says school district officials have a responsibility to the public and to bond investors to ensure their advisers are actually independent and acting in the best interests of taxpayers. ``To the extent that municipalities are participating in transactions they are not qualified for, there is an obligation to get good independent advice,'' he says.

More than two dozen Pennsylvania school districts bought swaps that bet on the spread between two interest rates. Many bet wrong. Since 2006, at least 27 school districts gambled that the spread would widen between either the five- or 10-year London interbank offered rate on the one hand and weekly municipal bond yields or the one-month Libor on the other.

The opposite happened: Spreads narrowed as long-term interest rates fell. The schools had to pay banks, or they could pay a steep exit fee, as Erie did with its swaption to cancel the deal.

 

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Company Default Risk Rises as Recession, Lending Concerns Mount

(Bloomberg) -- The risk of companies defaulting rose after reports showing a contracting U.S. service industry and tightening lending standards by banks fueled concern that borrowers will find it tougher to raise cash.

Benchmark credit-default swap indexes in the U.S. and Europe reached the highest levels in two weeks, a sign of eroding investor confidence in corporate creditworthiness. Contracts tied to the bonds of SLM Corp., the biggest U.S. student lender, rose after Standard & Poor's late yesterday cut the company's credit rating to one level above junk. Contracts on NXP BV, the chipmaker bought by a Kohlberg Kravis Roberts & Co.-led group, soared to the highest on record.

U.S. service industries unexpectedly shrank in January at the fastest pace since the last U.S. recession, an Institute for Supply Management index showed today. Banks lifted borrowing costs and made it harder for companies and households to raise funds over the past three months, the Federal Reserve's Senior Loan Officer Opinion Survey yesterday showed.

The weak economic and lending data ``is going to question people's ability to be optimistic about whether the monetary and fiscal stimulus is enough to turn things around later in the year,'' said Matthew Mish, a credit strategist at Barclays Capital in New York. Investors ``are going to have to confront the reality that the financial markets across the board are still extremely distressed and things aren't functioning properly.''

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates worsening perceptions of credit quality; a decline, the opposite.

CDX North America

The Markit CDX North America Investment Grade Index, a benchmark gauge of default risk tied to the bonds of 125 companies, climbed 7.5 basis points to 117 basis points at 10:11 a.m. in New York, according to Deutsche Bank AG. In Europe, Markit iTraxx Crossover Index of 50 companies with mostly high- risk, high-yield credit ratings soared 34 basis points to 503. In Asia, the Markit iTraxx Japan index increased 3 to 68.

A gauge of investor confidence in the U.S. high-yield, high- risk loan market fell to the lowest since it started trading Oct. 3. The LCDX Series 9, which falls as sentiment worsens, dropped as much as 0.55 point to 92.2, according to Goldman Sachs Group Inc.

Sallie Mae

Credit-default swaps on Reston, Virginia-based SLM, known as Sallie Mae, climbed 35 basis points to 435 basis points, according to broker Phoenix Partners Group in New York, the biggest climb in two weeks. S&P cut the company's credit rating to BBB- and said it may lower it further on concerns that ``higher funding costs, reduced profitability and potential asset quality deterioration will keep pressure on'' the company.

Contracts on NXP BV, soared 97 basis points to 943, according to CMA Datavision in London. KKR's purchase of Eindhoven, Netherlands-based NXP for 3.4 billion euros in August 2006 was ill-conceived because the chip industry relies on economic growth more than other businesses, the Financial Times today said in its ``Lex'' column. While it's unlikely the company will go bankrupt, the buyout firms probably won't achieve the profit levels they expected, the paper said.

Financial companies are reluctant to lend because they may face losses exceeding $265 billion on securities linked to subprime mortgages, Standard & Poor's said last week.

 

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Apple Adds Pricier IPods, IPhones With More Storage

(Bloomberg) -- Apple Inc. unveiled higher-priced models of its iPhone mobile handset and iPod media player with double the memory of previous versions.

The iPhone will now be available in a 16-gigbyte model for $499 and the iPod Touch in a $499, 32-gigabyte edition, the Cupertino, California-based company said today in a statement.

Apple's iPod shipment growth slowed last quarter, signaling that demand for the devices may be abating. The company introduced new models of the iPod, including the touch-screen version, in September to stimulate sales. Chief Executive Officer Steve Jobs said he expects to sell 10 million iPhone handsets this year.

Apple fell 11 cents to $131.54 at 9:39 a.m. New York time in Nasdaq Stock Market trading. The shares had dropped 34 percent this year before today.

 

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Treasuries Rise as Service Industries Contract, Stocks Decline

(Bloomberg) -- Treasuries rallied, pushing two-year note yields close to a four-year low, on growing speculation the Federal Reserve will cut interest rates further after a report showed service industries unexpectedly contracted last month.

Two-year notes gained the most in a week as traders bet the central bank will slash its benchmark rate by a half-percentage point next month, the third reduction this year. Yields have tumbled about 2 percentage points since mid-September, when the Fed started lowering rates to avert a recession amid a slumping housing market.

The report ``strongly corroborates people who have already been saying we're in recession,'' said T.J. Marta, a fixed- income strategist at RBC Capital Markets in New York. ``We're going to retest the lows in yields.''

The two-year yield fell about 11 basis points, or 0.11 percentage point, to 1.94 percent at 10:20 a.m. in New York, according to bond broker Cantor Fitzgerald LP. The yield touched 1.837 percent on Jan. 23, the lowest since April 2004. The price of the 2 1/8 percent security due January 2010 rose about 1/4, or $2.50 per $1,000 face amount, to 100 11/32. Ten-year note yields fell 11 basis points to 3.54 percent.

The Institute for Supply Management's non-manufacturing index, which reflects almost 90 percent of the economy, fell to 41.9, the lowest since October 2001, the last time the U.S. was in a recession, from 54.4 the prior month, the Tempe, Arizona- based ISM said. A reading below 50 signals contraction.

100 Percent

Traders now see a 100 percent chance that policy makers will cut their lending target a half-point to 2.5 percent at their next scheduled meeting on March 18, compared with a 68 percent chance yesterday, according to futures on the Chicago Board of Trade.

The gap between two- and 10-year note yields widened to about 1.6 percentage points, the most since September 2004, from 1.58 basis points yesterday. Shorter-maturity notes are more sensitive to Fed rate changes, while debt maturing in 10 years or more is influenced more by inflation expectations.

U.S. stocks fell, increasing demand for the fixed payments on government debt. The Standard & Poor's 500 Index dropped 1.6 percent in early trading.

 

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U.S. Stocks Fall After Service Industries Unexpectedly Shrink

(Bloomberg) -- U.S. stocks fell for a second day after American service industries declined to the lowest levels since 2001, reinforcing speculation the economy has tipped into a recession.

Exxon Mobil Corp., General Electric Co. and AT&T Inc. led declines in New York trading, and all 10 industry groups in the Standard & Poor's 500 Index dropped, after the Institute for Supply Management's index fell more than forecast in January. Goldman Sachs Group Inc. posted its biggest two-day drop since November on Oppenheimer & Co. analyst Meredith Whitney's downgrade of the largest securities firm.

``As the recession unfolds, then profits will disappoint,'' Stuart Schweitzer, who helps oversee $420 billion as the global markets strategist at JPMorgan Private Bank, said in a Bloomberg Television interview from New York. ``It's already under way.''

The S&P 500 lost 23.77, or 1.7 percent, to 1,357.05 at 10:24 a.m. in New York. The Dow Jones Industrial Average decreased 209.81, or 1.7 percent, to 12,425.35. The Nasdaq Composite Index slipped 32.45, or 1.4 percent, to 2,350.4. Shares also fell in Asia and Europe.

About six stocks dropped for every one that rose on the New York Stock Exchange after the ISM's non-manufacturing index, which reflects almost 90 percent of the economy, fell to 41.9 from 54.4 the prior month. A reading of 50 is the dividing line between growth and contraction.

GE, the second-largest U.S. company by market value, dropped 59 cents to $34.78. AT&T, the nation's biggest phone company, declined $1.09 to $37.07.

Energy Shares Slump

Crude oil for March delivery fell 1.7 percent to $88.47 a barrel in New York after the ISM report bolstered speculation fuel demand will slow in the U.S., the world's biggest energy consumer. Gold and copper prices also declined, dragging down shares of mining companies.

Exxon Mobil Corp., the biggest U.S. energy company, lost $1.49 to $83.95. Chevron Corp., the second-largest, declined $1.74 to $80.28. Freeport-McMoRan Copper & Gold Inc. retreated $3.85 to $87.33. Newmont Mining Corp. fell $1.04 to $49.87.

Goldman dropped $6.17 to $194.63. The firm was cut to ``perform'' from ``outperform'' by Oppenheimer's Whitney. The stock's valuation ``will not be sustainable in a year when Goldman Sachs will probably deliver results that will not be substantially better than its peers,'' Whitney wrote in a note dated Feb. 4.

Citigroup Inc., the biggest U.S. bank by assets, lost 73 cents to $28.49. Merrill Lynch & Co., the nation's third-largest securities firm, dropped $1.79 to $55.94. The S&P 500 Financials Index retreated 2.7 percent.

Ratings Watch

Banks and brokerages also retreated after Fitch Ratings said collateralized debt obligations may be downgraded as many as five levels. The biggest cuts will be to AAA rated CDOs that are based on credit-default swaps and aren't actively managed, according to ratings guidelines proposed by Fitch today. CDOs that package high-yield assets may be cut as many as three levels for the portions first in line for losses.

National Semiconductor Corp. fell 72 cents to $18.30. The maker of chips for devices such as Apple Inc.'s iPhone said revenue this quarter will be as much as $455 million. That's below the $484 million average estimate of analysts in a Bloomberg survey. The company on Dec. 6 forecast sales of $474 million to $495 million.

Texas Instruments Inc., the biggest maker of mobile-phone chips, dropped 88 cents to $30.28. Intel Corp., the world's largest chipmaker, lost 40 cents to $20.67.

Fed Bets

Traders boosted bets on Federal Reserve interest-rate cuts after the ISM report. Fed funds futures indicate a 98 percent chance policy makers will lower the target for overnight loans between banks by 0.5 percentage point to 2.5 percent by its March 18 policy meeting. That compares with 68 percent odds yesterday. The rest of the bets are for a quarter-point reduction.

General Motors Corp. slipped 66 cents to $26.91. GMAC LLC, the lending company that General Motors Corp. sold to a hedge fund manager, lost $724 million in the fourth quarter because home buyers didn't keep up with their mortgage payments. A group led by Cerberus Capital Management bought a 51 percent stake in GMAC in 2006.

NYSE Euronext slipped $4.06 to $78.67. The owner of securities exchanges on both sides of the Atlantic said fourth- quarter earnings more than tripled on record equity trading and new listings. Excluding merger costs and one-time charges, profit was in line with the average estimate of 12 analysts surveyed by Bloomberg.

 

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