Tuesday, May 8, 2007

Microsoft Should Buy Yahoo

In the battle of online search, Microsoft is again courting Yahoo, according to media reports
Microsoft should acquire Yahoo! in order to fend off Google and solidify the software giant's Internet presence, according to a Friday report by Merrill Lynch.

“The possible acquisition of Yahoo would be a strategic positive in our view,” said Justin Post, a Merrill Lynch analyst and author of the report.

Post said that Microsoft’s goal is to make advertising a significant new revenue stream, possibly even larger than the core operating system business, and buying Yahoo! would be a large step in that direction..

“A Yahoo/MSN-Microsoft combination would have garnered approximately 41% share in the US of search queries [in April] versus Google (nasdaq: GOOG - news - people ) with 44%,” Post said.

Google is already venturing into Microsoft’s territory with the recent launch of their spreadsheet and their partnership with Adobe Systems (nasdaq: ADBE - news - people ), Post said.

Yahoo! would be Microsoft's best prospect from a strategic standpoint, according to Post, because Bill Gates and company could thereby eliminate a top competitor and because Microsoft’s search and advertising focus on personal computers, mobile dives and video games fits well with Yahoo!’s business strategy.

The latter company’s large presence in Japan would also bolster Microsoft’s business platform in Asia, the analyst said.

A good second option, however, could be eBay (nasdaq: EBAY - news - people ), he added.

“Worse case, an acquisition of eBay or Yahoo! could cost Microsoft $5 a share if completely unsuccessful,” Post said. “However, Google’s potential encroachment on Microsoft’s core software market, using Internet profitability to fund software investment, represents a long-term business risk.”

In a way, they’re two tech titans that could badly use each other: Microsoft (MSFT) and Yahoo (YHOO), both hobbled by an 800-pound gorilla that has come to dominate search.

According to newspaper reports May 4, Microsoft has asked Yahoo to enter formal negotiations for an acquisition that could be worth $50 billion. Yahoo's market capitalization was about $38 billion at the close of trading May 3.

Reports of the deal sent Yahoo shares jumping 17% in premarket trading, while Microsoft slipped 1.5%.

The Wall Street Journal and the New York Post reported Friday that executives of the two companies are in early-stage discussions of a merger or some other kind of collaboration, although Microsoft officials would prefer to acquire the company outright. The companies held similar discussions a year ago, but no deal came to fruition, the newspaper reported, citing people familiar with the talks.

Still, any deal is far from certain, the reports noted.

Among bloggers on the Net, there is plenty of skepticism about a merger because of the size of the deal, the differences in culture, the abundance of executive egos, and the redundancies in technology. "If Microsoft buys Yahoo, Microsoft should immediately spin the Yahoo-MSN business out as a separate company," says Henry Blodget, the one-time analyst at Merrill Lynch (ML), who now writes the Internet Outsider blog. "If it doesn't, both Yahoo and MSN will die." (see BusinessWeek.com, 5/4/07, "Yahoo, MSN "Will Die"").

Microsoft is feeling increasing pressure to compete with Google (GOOG), which plans to beef up its portfolio with a $3.1 billion purchase of online advertising company DoubleClick.

Microsoft currently trails both Yahoo and Google in the lucrative and growing business of Web search. For its part, Yahoo has stumbled in recent years with a lack of strategic focus and laggardly technology at a time when Google has been able to monetize its search prowess to a degree that has startled investors.

Google won a search advertising deal with AOL (TWX) in 2005 that the Post said Microsoft wanted. In addition, Google has developed an array of Web-based software that, while not as robust as the tools in Microsoft’s suite of Office products, presents a severe future threat.

The Post story said Microsoft and Yahoo have held informal talks over the years and said Microsoft's latest approach to Yahoo signals increased urgency.

Earlier this week, Yahoo said it would buy 80 percent of advertising exchange Right Media for $680 million, increasing its stake in that company to full control.

Yahoo shares surged nearly $5, or 17%, to $32.96 at midday trading, near its 52-week high of $34. Shares of Microsoft fell 1.5% to $30.51


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