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Could Microsoft sweeten the pot by structuring the Yahoo deal as a tax-free merger?
Marie Leone, CFO.com | US
February 4, 2008
Internet time is faster than anyone ever suspected. Amid the pre-Super Bowl chatter last Friday, Microsoft made a hostile $44.6 billion bid to acquire Yahoo; Google — Yahoo's main online search rival and Microsoft's primary competitor on the Web — accused Microsoft of using the merger to seize control of the Internet; and Google's CEO offered Yahoo a helping hand to fend off Microsoft.
Meanwhile, analyses of the potential blockbuster deal have been non-stop, with Microsoft and Yahoo providing boilerplate responses as speculation swirls around them. Yahoo, for example, noted in a press statement that its board would evaluate the unsolicited proposal "carefully and promptly ... and pursue the best course of action to maximize long-term value for shareholders." Microsoft's statements were more grand, flaunting the idea that the combined companies would thwart Google's hold on the online advertising market and "enable us to achieve scale economics while reaching R&D critical mass to deliver innovation breakthroughs."
Platitudes aside, there's another angle for observers to keep an eye on: a potential tax break for Yahoo co-founders Jerry Yang and David Filo. If a merger deal is in the offing, Microsoft could dangle in front of the founders what's known as a "double dummy" structure. The maneuver allows the stock payment portion of a deal to remain tax-free.
The idea that Yahoo shareholders are being offered a cash and stock deal leaves the door open for a double dummy structure, contends Robert Willens, founder of tax publishing and advisory firm Robert Willens LLC.
Willens says, however, double-dummies are rarely used because they complicate corporate structures by creating a permanent holding company at the top. But if the deal is so important to complete that the resulting corporate structure can be overlooked, the tax break can be used as a sweetener.
While neither Microsoft nor Yahoo has provided much detail about how the proposed acquisition might be structured, here's how a double dummy might hypothetically work. Let's say that Microsoft and Yahoo form a new holding company called MergerCo. Next, MergerCo creates two dummy subsidiaries that exist only for the sake of the transaction: SubMicrosoft and SubYahoo. SubMicrosoft mergers with Microsoft, while SubYahoo mergers with Yahoo. Microsoft and Yahoo survive the merger, while their Sub counterparts are eventually shut down.
Microsoft shareholders then exchange their stock on a one-for-one, tax-free basis for stock in MergerCo. Meanwhile, Yahoo shareholders exchange their stock for cash or stock in MergerCo – although no more than 30 percent of the consideration can be stock if the transaction is to remain tax-free. As a result, Yahoo shareholders only pay taxes on the cash portion of the transaction.
The structure is beneficial to shareholders who hold the company stock at very low share prices, which likely includes Yahoo's Yang and Filo and other early-stage investors. Those investors probably hold shares that were bought at the initial public offering price of $13 per share or lower and would be hit with a 15 percent capital gains tax if Microsoft's $31-per-share offer is accepted.
Even according to a conservative estimate, a double-dummy structure could save the founders millions of dollars in taxes. For instance, consider a scenario in which 25 percent of the 43 million shares Yang currently owns were bought for $13 per share. That part of his portfolio, 10.75 million shares, would be worth $193.5 million if Yahoo accepts the existing Microsoft offer. Also assume that Yang would take 70 percent of the proceeds in cash and 30 percent in stock. The $58 million in stock (3.2 million shares multiplied by an $18-per-share gain) means that in the example, Yang could save up to $8.7 million in capital gains taxes. Even if he held onto the stock, it's basis price would be $31, not $13 dollars, so any future gains — and attendant taxes — would be cut substantially.
The same would be true for Filo, who now holds over 78 million shares. Using the same calculations —with 25 percent or 19.5 million shares having a basis of $13 — Filo could save up to $16 million in capital gains taxes via the merger. Nevertheless, it's too early to tell whether the double dummy sweetener is enough to push Yang or Filo to champion the deal.
The structure has, however, been used in other recent high-profile mergers. Last year shareholders at Siebel Systems used a double dummy to cut the tax bills of founder Thomas Siebel and other shareholders. The Bancroft family, former owners of Dow Jones & Co., also used a variation of the structure to cut their payment to the Internal Revenue Service after Rupert Murdoch's News Corp. bought the media conglomerate. Another 2007 union, the $4.6-billion merger between Vulcan Materials and Florida Rock Industries, also used the double dummy to give the Baker family, founders of Florida Rock, a tax break.
In 1978, Unilever completed what's been widely reported as the first double dummy transaction, using the structure to acquire National Starch and Chemical Co. Since then, the structue has been used by Disney to acquire ABC/Capital Cities, by Berkshire Hathaway to acquire General Re, and by Time Warner to acquire Turner Broadcasting.