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The week the Verizon/Yahoo deal almost fell apart

Verizon Communications Inc.'s purchase of Yahoo! Inc.'s operating business is set to close sometime in the second quarter. But a recent SEC filing shows how close the deal came to falling apart.

During the first week of February 2017, both companies considered the possibility of walking away from the transaction. The discovery of multiple data breaches at Yahoo had led Verizon to ask for a significant price reduction on the original $4.83 billion deal, a reduction that Yahoo's board was unwilling to accept. Had the two sides not found a number they could agree upon, the deal would have been off.

But to understand why it was such a difficult decision requires a little background.

When Verizon first offered to buy Yahoo in the first half of 2016, the telecom giant was one of a large group of bidders. According to Yahoo, a total of 19 interested parties attended management presentations between April 1, 2016, and April 8, 2016, exploring the potential for a deal. From there, more than a dozen parties, including three strategic bidders and 11 financial sponsor bidders, submitted preliminary nonbinding indications of interest.

After months of negotiations and meetings, the pool narrowed to five bidders. Of those, Verizon offered the highest base purchase price at $4.83 billion. The next highest base price offer was $4.35 billion, while two others came in at $4.0 billion and $4.05 billion. Taking everything into account, including varying termination fees and the assets covered by each offer, Yahoo selected Verizon's bid, and the two companies finalized their agreement in July 2016.

The news generated a bevy of snarky headlines and comments, with Forbes describing the purchase as the "saddest $5 billion deal in tech history." Nevertheless, all seemed to be going according to plan as the summer closed.

But then came the fall.

On Sept. 22, 2016, Yahoo publicly disclosed that data linked with at least 500 million user accounts was stolen in late 2014. Yahoo had limited information at the time, but the U.S. Justice Department has since revealed hackers — including two officers of the Russian Federal Security Service — used stolen information to gain unauthorized access to the contents of accounts at Yahoo, Alphabet Inc.-unit Google Inc. and other webmail providers. Among the account holders targeted were Russian journalists, U.S. and Russian government officials and private-sector employees of financial, transportation and other companies.

Throughout October 2016, Yahoo board members met periodically to discuss how the 2014 data breach might affect the company's pending sale to Verizon. Toward the end of the month, the board agreed Yahoo should offer to retain liability for "a portion of certain costs and expenses" arising from the incident.

By Nov. 8, 2016, Thomas McInerney — a Yahoo board member who is set to take over as CEO of Yahoo, to be renamed Altaba Inc., after the Verizon sale — and Verizon CEO Lowell McAdam had reached a preliminary understanding on an agreement.

But that understanding was seemingly torpedoed a day later when Yahoo disclosed on Nov. 9, 2016, that forged cookies had been used to access users' accounts without a password. Then on Dec. 14, 2016, Yahoo further revealed an unauthorized third party had stolen data associated with more than 1 billion user accounts in August 2013.

These revelations put the Verizon deal on shaky ground. As early as October 2016, the New York Post had reported Verizon was seeking a $1 billion discount on the purchase, though McAdam at the time called those reports "total speculation." By Feb. 1, 2017, McAdam had changed his tune — privately, if not publicly.

According to the SEC filing, McAdam held a call with McInerney on Feb. 1, 2017, during which the Verizon CEO laid out three options. One, Yahoo could give Verizon time to complete its own evaluation of the impact of the data breaches, a process that could take "several months." After that time, Verizon would decide "how to proceed and whether to assert any legal rights against Yahoo." Two, Yahoo could agree to a purchase price reduction. Or three, both Verizon and Yahoo could mutually decide to walk away from the deal.

McInerney asked how big a reduction McAdam had in mind. McAdam said he wasn't sure, but $925 million could be appropriate.

In the days that followed, Yahoo's board weighed the alternatives raised by Verizon and whether to walk away from the transaction. Should Yahoo pursue a spinoff rather than a sale? Or could the internet company strike a new deal agreement with one of the previous bidders, and would that agreement contain more favorable terms at this point? What would the legal ramifications be?

Remember, of the five final offers, Verizon had offered the highest base purchase price, topping the others by almost $480 million. And that was before the data breaches had been revealed.

Ultimately, based on input from myriad financial and legal advisers, Yahoo's board decided to stick with the Verizon deal though it decided a $925 million price cut was too steep. The parties tentatively agreed on a price reduction of $350 million on Feb. 9.

Verizon is now set to pay $4.48 billion for Yahoo's operating business. Under the new terms, Yahoo will shoulder any liabilities arising from shareholder lawsuits and SEC investigations resulting from the data security breaches, while the two companies will share cash liabilities related to non-SEC government investigations and third-party litigation.

Only time will tell whether both sides made the right decision in pressing forward.

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