Yahoo! Needs to Play a Winning Hand

SAN FRANCISCO -- Yahoo!'s(YHOO) first-quarter results on Tuesday will go a long way in determining whether the Internet giant can squeeze more money out of Microsoft(MSFT).

Sunnyvale, Calif.-based Yahoo! has already reiterated its revenue guidance of $1.28 billion to $1.38 billion for the quarter and $5.35 billion to $5.95 billion for the year, leaving many analysts believing that the company will -- at the very least -- meet those estimates.

If it does meet or surpass estimates, Yahoo! has a stronger case that it's worth more than the $31-a-share buyout price that Microsoft is now offering.

Wall Street analysts predict first-quarter revenue for Yahoo! of $1.32 billion and earnings of 9 cents a share. For the year, they estimate revenue of $5.63 billion.

Microsoft, which made a play for Yahoo! after it reported weak fourth-quarter results, has warned that if no deal is reached, it will initiate a proxy fight to oust Yahoo!'s board, replacing it with candidates who would favor a Microsoft takeover.

"With the three-week ultimatum from Microsoft rapidly looming (effectively April 26th), we think Yahoo! management will have focused hard on the current quarter," wrote Sanford Bernstein analyst Jeffrey Lindsay in a recent research note.

Lindsay further noted that Yahoo! had taken its guidance very low in the fourth quarter, and a miss could seriously undermine any efforts to convince investors that the company still has plenty of value. Stanford Bernstein makes a market in Yahoo! shares.

Indeed, many observers have suggested that Yahoo!'s standoffishness in its dealings to date with Microsoft goes a long way to prove that the company knows it is sitting on a strong earnings report.

"Failure to meet these diminished expectations would greatly strengthen Microsoft's hand in the current takeover battle," Lindsay said.

Yahoo! has maintained from the start that Microsoft is substantially undervaluing the company at $31 a share. It has also sought to come up with alternatives to a merger by outsourcing some of its online ads in the U.S. market to Google(GOOG), as well as engaging in talks with Time Warner's(TWX) AOL division.

RBC Capital Markets analyst Ross Sandler noted in his research that Yahoo!'s reaffirmed guidance speaks volumes, especially given the company's strong track record of beating the midpoint of guidance over the past five quarters.

"We continue to believe that the YHOO-MSFT transaction comes to fruition, and if Yahoo can post upside in 1Q, there is upside bias to the takeover value," Sandler wrote. RBC makes a market in Yahoo! shares.

Mark Mahaney, an analyst for Citigroup, recently upgraded Yahoo! to a buy, noting that the company's stock is trading at a 10% discount to Microsoft's current offer, and at a 20% discount to a potential bid of $34 a share, which leaves it with an attractive risk-reward outlook. Yahoo! shares closed Monday at $28.55.

"In fact, given the committed MSFT bid, we view YHOO as one of the best defensive plays in the Internet sector in this recessionary environment," Mahaney wrote. "Also, at the margin, we view Google's relatively strong first quarter results as increasing YHOO's negotiating leverage." Citigroup has an investment banking relationship with Yahoo!.

Last Thursday, Google blew past first-quarter estimates, offering some comfort to investors who had worried that the Internet behemoth would fall prey to macroeconomic pressures.

Jeetil Patel, an analyst for Deutsche Bank, wrote in his research that he expects some potential upside to Yahoo!'s revenue guidance, "considering the company's aggressive approach to demonstrate its value and pushing the benefits of the new platform around the 3Q/4Q timeframe of the year." Deutsche Bank makes a market in Yahoo! shares.