Thursday, March 2, 2017

Yahoo Verizon Breach Impact on Future M&A

Executive Summary: Cybersecurity is likely to take another step in developing a quantitative number as to its value to an organization. According to Vanity Fair, Yahoo, a collection of web properties including Flickr and Tumbir), was worth $128B at its peak, was mismanaged, and agreed to be bought for $4.8B. That SEC filing is here. LATIMES reports some analysts do not feel the matchup will work. Now that it is clear Yahoo knew about the data breach before the Verizon acquisition and did not disclose, that is potentially a deal breaker. That SEC filing is here. on 12/15/16 new information indicates that up to a billion accounts have been compromised. Time has an interesting analysis. 3/2/17 The CEO is giving up her bonus and the CLO has resigned.

Because it is the largest known data breach in history, (originally reported as 500M, but MarketWatch and BusinessInsider say potentially 1B (which is starting to be more likely), it is setting up to become "the mother of" all data breach settlements. Forbes points out that poor cybersecurity can lead to lawsuits. Since many people use the same password on multiple systems, one use of the breached data is to brute force the hashes to test on other systems. Threatpost says most of the Yahoo hashes are bcrypt, (potentially expensive to brute force), but a "small percentage" are the outdated, unsafe, MD5.

6/8/17 All data indicates the merger will close followed by a 15% reduction in force for AOL-Yahoo.

CEO Marissa Mayer is now out of a job when the merger completes. She does have a handsome severance package. But the new CEO, Thomas McInerney, has a better package. 

Table of contents:
1) What will the financial impact be for Yahoo and Verizon in terms of the merger?
2) What can we expect in terms of Yahoo's stock valuation?
3) What are the general costs of a data breach?
4) What's next for Verizon?
5) Deja Vu. Operation Aurora 2009

1) What will the financial impact be for Yahoo and Verizon in terms of the merger? The $4.8B deal for at least 800M accounts was supposed to close 1qtr 2017. That means we should know fairly soon. Currently experts are divided. 10/26/16 Fast Company posted an inscrutable article about an interview with Verizon executive Marni Walden that seems to imply there isn't a clear direction.

1.1 Some say the merger will be damaged or the price will change:

Yahoo has now disclosed Verizon may back out of the deal. To make matters worse, there may be another data breach to deal with. Inquisitur reports, (via CNN), that hacked data was sold in three different $300,000 deals and that Verizon is renegotiating. One legal professor is predicting this could set a precedent that will be taught in law schools. 1/5/17 A Verizon executive states they are not sure what they are going to do. USA Today, "They (Verizon) are going to get a price discount. 

10/6/16 a story, (based on a NY Post exclusive), broke on USA today that Verizon was asking for a $1B discount. 12/16/16 Fortune reports they are asking to reprice Yahoo's assets. 1/24/16 the situation is delaying the deal.

The Wall Street Journal reports Verizon CEO "Mr. McAdam, speaking at a technology conference in Menlo Park, Calif., on Monday, said he still sees Yahoo as “a real value asset,” but added: “In fairness we are still understanding what was going on and defining whether it was a material impact on the business or not.

CNBC reports Verizon CEO Lowell McAdam saying "he was "not that shocked" about a Yahoo data breach where the information from 500 million users was stolen, saying it was not a matter of if, but when.

10/13/16 The Wall Street Journal reports "[Verizon]General Counsel Craig Silliman said it was “reasonable” to believe that the breach represented a material event that could allow it to change the terms of the takeover. 

“If they believe that it’s not, then they’ll need to show us that,” said Mr. Silliman, who has been leading Verizon’s review of the situation."

10/18/16 Chicago Tribune reports earnings have faltered for four consecutive quarters.  The condensed financial information is here. CNBC points out they did profit and beat analyst consensus. Investorplace believes that since Verizon earnings are pretty flat in the highly competitive wireless marketplace, they need Yahoo and a reduced price would be a bonus. 10/23/16 WSJ reports that AT&T, (also suffering from flat earnings and competition from Sprint and T Mobile) is making an offer for Time Warner.

10/20/16 WSJ reports Verizon is revisiting the deal. Chicago Tribune quotes Verizon CFO Fran Shammo saying "Material Impact".

1.2 One possibility is that it will have no impact on the deal or even the selling price, NY Post reports, "Some experts said it would be hard for Verizon to prove the hacking was a material adverse change — the one surefire legal gambit that could scuttle the deal."

  The NY Times reports, "Brian Quinn, an associate professor at Boston College Law School, said Verizon had two main options if it decided to use the hack as leverage in setting the terms of the deal.

“They could say, ‘This thing is huge. We want to walk away from the transaction,’” he said. Were Verizon to try to claim that the breach was so severe it was grounds to terminate the deal, it would have to prove that the hack amounted to a material adverse effect on the value of Yahoo.

Such claims can be difficult to prove in court. According to Mr. Quinn’s reading of the merger document for the deal, Verizon would most likely have to prove that certain high-level Yahoo employees were aware of the severity of the hack before the deal was agreed upon, and intentionally withheld that information."

Fortune reports, "Nonetheless, it would be very tough sledding to get a Delaware court to agree a so-called material adverse event had occurred, particularly given that evidence of reduced usage and related revenue declines, for example, would not be immediately available for quite some time."

11/17/16 Investopedia reports AOL is getting ready to lay off part of their sales force, which industry analysts claim indicates the deal will go through.

1.21 When Yahoo knew has a large impact on the deal!

Yahoo has now disclosed they knew about the compromise before the Verizon deal. That puts all the cards in Verizon's court.

Quartz discusses whether Yahoo did or did not know about the breach they announced in September back in July, "In July, a well-known hacker who goes by the name “Peace” told Motherboard that he possessed 200 million Yahoo user details, which were going for 3 bitcoins a pop on a darknet market called TheRealDeal. Yahoo confirmed that it was “aware” of the claim at the time. 

This is the incident that Mayer was aware of in July, as the FT’s anonymous source says: “Marissa was aware absolutely—she was aware and involved when Peace surfaced this allegation in July,” according to the source.

The attempt to verify Peace’s claim then led Yahoo to discover the latest breach, of 500 million user records, according to the FT. Yahoo has attributed this hack not to Peace but to a “state-sponsored actor.” What’s not clear now is when Yahoo discovered the confirmed breach. It seems a safe bet that this discovery happened sometime after Peace made his claims in late July, which is also after the Verizon deal was clinched, on July 25."

NY Post, "Yahoo would have to pay some $145 million if the deal somehow falls apart and it is to blame. While the hack is “upsetting,” it isn’t clear “it is a material adverse change,” one big Yahoo shareholder told The Post."

What is unique in this case is that Verizon has a fairly advanced cybersecurity division. They are uniquely suited to investigate and determine the potential impact to the deal. That said, they have recently suffered their own breachA recent thread posted on a guarded cybercrime forum advertised a database containing contact information for roughly 1.5 million Verizon Enterprise customers for sale at $100,000 for the lot.

10/13/16 Business Insider reported "CEO Marissa Mayer kept secrets from key members of the security team".

1.4 When there is blood in the water sharks are sure to come. Many times when a company is in trouble, other allegations surface. Some of these are inevitable, others are lawsuits and similar hoping the company in trouble will settle.

1.4.1 Further damage by NSA spying news breach, 10/5/16 Reuters released a story that Yahoo searched incoming emails for US intelligence purposes. That would seem to be at odds with Yahoo's transparency policy. Slashdot reports, "The two former employees say that the decision Yahoo CEO Marissa Mayer made to obey the directive resulted in the June 2015 departure of CISO Alex Stamos, who left to work for Facebook." A Google search on 10/6/16 for "yahoo scanned emails" yielded 5.46M results. Fortune reports this could cause trouble with European customers. PredictWallStreet still does not appear to have priced the damage since the breach disclosure; 76% of the responders expect the price to go up. This is inline with the NSADAQ consensus of BUY. 10/5 and 10/6 YHOO closed at 43.71 and 43.68. EFF reports the specific instructions the government gave Yahoo may have to be disclosed. "Section 402 of the USA FREEDOM Act, passed in June 2015, specifically requires government officials to “conduct a declassification review of each decision, order, or opinion issued” by the FISC “that includes a significant construction or interpretation of any provision of law.” The Yahoo order would appear to fall squarely within this provision."

1.4.2 Mercury News reports Scott Ard a former executive that was fired has filed a lawsuit against Yahoo, because Marissa Mayer systematically sought to remove male employees.

1.4.3 Fortune reports Access Now, (international civil rights group) is interested in the email scanning issue.

1.4.4 NY Post has a fact free article that "Marissa Mayer’s days appear numbered as her company disappears"

2) What can we expect in terms of Yahoo's stock valuation? I have been pouring over the financial analysts reports and they seem to be oblivious to the impact of the breach, but I expect that will change. Is the bad news already priced into the stock price?  This may be an exception to an efficient market. After the merger announcement YHOO drifted up to 44.71 on September 6. Now, it is obviously drifting down, and closed September 26 at 42.29. That isn't necessarily surprising, not all data breaches have the impact that Target's did, (profits YoY -40%, earnings YoY - 46%, EPS $.81 down from $1.47, share price from about 70 to 56 now almost back to 70).

However, this is the mother of all data breaches. It is possible there isn't a quant model for something of this size.  According to Yahoo Finance :), 52 week range is 26.15 - 44.92 and 1 year target is 42.75 where they already are. So there is a lot more room for downside than upside.

11/10/16 My prediction is that the quant models will start to be adjusted. The first chart shows an 18% increase for the year. The expectation they will be acquired must be driving that, because revenues certainly are not. But in the past month they are down my 8%, (second chart).  Also look at the trading spikes along the bottom, that can only happen with computer driven trading.

3) What are the general costs of a data breach? The IBM Ponemon 2016 study on data breach costs is probably the most authoritative. According to the study, the average cost is $4M, (compared to Target's 252M before insurance and tax write offs). The cost has increased 29% since 2013. In the United States the average cost per capita is $221, (221 x 500k = 110.5B more than 4x Target's final cost to top-bound this though free/non-revenue accounts arguably have lower value.).

USA Today has what I consider a more reasonable guesstimate, ""I would [ask for a pause] if I was the buyer," said Chris Bulger, founder of Boston tech advisory bank Bulger Partners. "I would consider this a materially adverse change (a factor that could allow a party to back out of a sale) until my lawyer said don’t worry about it."

Bulger estimates that Yahoo will likely have to pay at least $10 per user in reparations. That could amount to $5 billion — more than Verizon's $4.8 billion paying price — making Yahoo "worthless," he said."

3.1 Non-revenue doesn't necessarily mean free or of low value. A deal struck with AT&T 15 years ago allowed Yahoo users to manage their AT&T accounts from Yahoo mail. According to CNET, "The hack puts AT&T in an uncomfortable position. The company is still waiting for data from Yahoo on the specific customers who may have been affected, according to a person familiar with their dealings.

"We began investigating immediately and requested information from Yahoo necessary to determine which email accounts may have been compromised," the company said in a statement. "In the meantime, we are in the process of notifying potentially affected customers.""

3.2 Class action Law suits. The Hill reports a class action suit was filed in California.  USA Today reports two more. The Home Depot settlement, (50M users) was $19.5M, (less than forty cents per user). Target was $39M for 40M users. CNBC references a suit claiming gross negligence.

3.3 SEC investigation and/or fines.  In June 2016, the SEC announced Morgan Stanley agreed to pay $1M over an insider data breach of 730,000 customer accounts, about $1.37 per account.  Assuming that ratio, Yahoo's potential liability could be $685M.

3.3.1 SEC rules may need to be clarified, Reuters, "And the vagueness of SEC's 2011 rules on disclosure and its failure to enforce them are drawing equal attention, privacy lawyers and cyber security experts said."

3.4 Cost of business disruption. Fortune ran a Reuters story saying "many users" closed their Yahoo accounts. The number of active accounts presumably was a factor in the valuation, (on July 15 Yahoo started closing accounts that had not been used in a year). OCT 10 2016 ET reports that they disabled forwarding, so users have to use Yahoo to read their mail.

NOTE: Closing your Yahoo account may be more complex than you might guess. warns you could lose your other Yahoo services like Flickr and the account will still accept email for 90 days. SecurityWeek and TrendMicro disclosed changing the Yahoo password does not prevent your iPhone mail from accessing Yahoo because it has a permanent access credential.

According to Investopedia, "Yahoo’s core business has been slowly declining as the PC advertising and search engine space has come to be dominated by the likes of Google Inc. (GOOG) and Amazon (AMZN)." Depending on who you ask, recode, PR News, Marketing Land, Bloom Reach,  somewhere between 44% and 55% of all online product searches begin with Amazon.  After the breach, it is likely less people will use Yahoo.

3.5 Cost to diversity. Women executives have been leaving the company, no one is sure what. Reuters reports "Women leaders organically left because other opportunities were more appropriate for them," said Margenett Moore-Roberts, Yahoo's global head of diversity and inclusion. She said most of the women executives who left did so voluntarily after the plan to sell the core company was announced.

4) What's next for Verizon?

If Materially Adverse Change
          Price reduction OR Verizon walks away, (and possibly makes an offer for Twitter*)
          It is going to be a long winter for Verizon

* Fortune magazine reports Twitter will probably be bought at around $27 per share. 10/23/16 maybe not it closed on Friday at 18.09 and can't seem to find a buyer. Motley Fool reports declined to make an offer.

4.1 This may be a blessing, combining AOL and Yahoo seems a bit like bows and arrows against modern weapons. Quartz has a pre-breach article claiming the merger will not end well.

5) Deja Vu. Operation Aurora 2009

Wikipedia reports Yahoo was targeted by Operation Aurora in 2009. Multiple sources, Darkreading, Security Affairs, Nextrio, mention they were targeted, but the impact is sketchy. SANS NewsBites reports, "A number of foreign journalists based in China are claiming their Yahoo email accounts have been hacked. The Foreign Correspondents Club of China (FCCC) has confirmed that eight journalists have had their Yahoo email accounts hacked including one that had a forwarding address added to the account. Yahoo has made no direct comment regarding the claims and says that it is "committed to protecting user security and privacy." Earlier this year the Google mail accounts of Chinese dissidents were targeted in an attack on Google. The FCCC is advising users to take care when using email, especially for sensitive issues, and warning people that "email does not appear to be secure in China, and that alternate means of arranging interviews and conducting other sensitive business are often preferable". "