May 12, 2008: 12:15 PM EDT
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Overplaying their hand

How two big, long-term investors, Bill Miller and Gordon Crawford, played a short-term game with the Yahoo/Microsoft deal and stumbled.

By Allan Sloan, senior editor-at-large

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Legg Mason's Bill Miller

(Fortune Magazine) -- There are different kinds of investors in the world. One kind is a long-term patient type who runs mutual funds for the average Joe. A second is a risk arbitrageur - known on Wall Street as an "arb" - who speculates on pending deals. When a proposed takeover surfaces and the target's stock price runs up, Mr. Patience tends to sell to the arbs, happy to take his profit and letting the arbs bear the risk of whether the deal gets done and at what price.

Recently, however, two of the biggest and best-known mutual fund investors - Gordon Crawford of Capital Research Global Investors and Bill Miller of the Legg Mason Value Trust (LMVRX) - blurred the distinction between the investment and arb worlds, and their shareholders paid the price.

What I'm referring to, of course, is the Microsoft-Yahoo takeover circus featuring big bucks, big egos, and enough clowns to staff a Big Top. The opening act was Microsoft's $31-a-share hostile bid, which was followed by months of posturing and strutting by various parties. The show ended with a flying dismount by Microsoft (MSFT, Fortune 500), which raised its offer to $33, bailed when it was turned down, and sent Yahoo (YHOO, Fortune 500) into free fall.

I was surprised by the way Crawford and Miller, two managers for whom I have enormous respect, conducted themselves. They could have sold their stock to arbs and pocketed a 50% increase from the pre-Microsoft price. Instead, they agitated publicly for a higher price, then blamed chief Yahoo Jerry Yang and the board when the Softies walked, rather than admit they'd taken a chance on a higher price and it hadn't worked out.

I was also surprised that Crawford and Miller took offense when I suggested they'd acted like arbs - which I consider an observation, not an insult. Some of my best friends are arbs.

"I'm not an arb," snapped Crawford, who owns 6% of Yahoo. (An affiliate owns another 10%.) "I'm a long-term shareholder who expected the board to do the right thing.... I'm not whining because a takeover deal fell through," he said, "I'm a big boy." He said Yahoo's board has acted so badly that he feels compelled to complain publicly for what he says is only the second time in 36 years in the business. (The first involved Steve Case, former chairman of Fortune's publisher, Time Warner (TWX, Fortune 500), in which Crawford still owns a major stake.) Is Crawford's Yahoo behavior arblike? You've got both sides, you can decide for yourself.

Now, to Miller, who also owns 6% of Yahoo. "I don't see it that way," he said, when I asked him why he morphed into an arb. He said that Microsoft's stock-and-cash offer was worth only about $29 because the software maker's stock tanked after the deal was unveiled. Thus, with Yahoo's stock selling at $28, "I thought there was a 10% downside and a 30% upside," he explained, "it was a probabilistic assumption of risk and reward." That's arb talk - but Miller says he looks at all his holdings this way.

It's entirely possible that Microsoft will have surfaced with another offer by the time you read this. But my point's still valid: If you play the arb game and lose, take your lumps and don't publicly blame anyone but yourself. You could have sold and transferred the risk to someone else. You chose not to do that. Arb's the breaks.

The bucket fillers

They teach you in Business 101 (as well as in Clichés 101) that when you're trying to get out of a hole, the first step is to stop digging it deeper. With that in mind, I'm appalled by the way many capital-strapped big banks and brokerage houses continue paying substantial cash dividends to common shareholders even as they're raising vast amounts of expensive new capital to shore up their balance sheets.

Maybe these payments prop up the stock price in the short term - but they come at a steep long-term cost. Bank of America is paying common stockholders an annualized $11.4 billion a year; Citi, $6.9 billion; Merrill, $1.4 billion. Why would you fill a bucket from the top while letting water gush out of the bottom? Maybe these firms need to take a remedial course: Common Sense 101.

REPORTER ASSOCIATE Doris Burke contributed to this article. To top of page

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