Microsoft Corp. (MSFT) bankers recently contacted Facebook Inc. and made inquiries about purchasing the popular social networking site, the Wall Street Journal reported.  

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No active discussions have been held between the two companies, but Microsoft has been on the prowl since withdrawing its bid for Yahoo Inc. (YHOO).

Last year, Microsoft bought a 1.6% stake in Facebook Inc. for $240 million, has expressed an interest in buying the site over the past three years. But Facebook’s Chief Executive, Mark Zuckerberg, has been reluctant to sell, opting instead to work towards an initial public offering.

Facebook, with more than 70 million users, drew 109.2 million visitors in March, according to comScore Inc., an improvement of 240% from a year ago. The company expects between $300 million and $350 million in revenue this year, up from $150 million last year, the Journal reported.

A tie-up with Facebook is one of the options Money Morning previously identified as an avenue Microsoft could pursue as a means of drawing consumer traffic and advertisers to its online services.

The company may also look to Time Warner Inc.’s (TWX) AOL or News Corp.’s (NWS) Fox Interactive Media business units. Many analysts have also suggested Yahoo and Microsoft might return to the bargaining table. Legg Mason Inc. (LM) fund manager Bill Miller is one of those analysts.

"I’m more puzzled by Microsoft’s not going up to $37 than Yahoo’s wanting to walk away," Miller said told Bloomberg News. "If they want to be a viable competitor, I would expect them to come back."

Microsoft withdrew its bid for Yahoo Saturday after the country’s second largest web portal turned down its $33 a share, $47.5 billion offer.

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Less than a week after withdrawing its bid Yahoo! Inc. (YHOO), Microsoft Corp. (MSFT) broke ground on a $280 million research and development campus in Beijing.

The center, to be completed in 2010, will be the company’s largest outside the United States with enough room for 5,000 employees, according to a report from Bloomberg. The center will add to a base of operations in the world’s most rapidly developing nation that already includes centers in Shanghai, Shenzen and another in Beijing.

The company had approximately 3,000 employees in China as of November, half of which were full-time, according to a company spokesperson. Microsoft hopes to double the amount of full time engineers to 3,000 by 2010.
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China has some 225 million Internet users, according to the China Internet Network Information Center. BDA China, a Beijing-based consulting and research firm, thinks that figure is closer to 228 million. And in the next year, another 60 million China consumers are expected to join the online world.

According to Ministry of Industry and Information (MII) statistics, China’s software industry recorded of $20.7 billion (144.36 billion yuan) in sales revenue in the first quarter of 2008 up 29.9% year-over-year.

Software technology service was one of the nation’s fastest growing sectors, with 46.4% year-over-year growth. Software sales grew 26.2% to $7 billion (49.3 billion yuan) and accounted for 34% of total software industry revenue. Software export revenue reached $2.4 billion, up 54.3%.

Chinese authorities are also stepping up their efforts to tackle a piracy epidemic that has robbed software companies of an estimated $5.43 billion in revenue. In 2006, about 82% of software run on PCs in China was pirated, according to the Business Software Alliance. However that’s an improvement over 92% in 2003. Just a 9% decline in piracy reportedly saved software companies $864 million in lost revenue.

"Piracy in China is putting pressure on companies to develop software products that aren’t as vulnerable to illegal copying," Liu Ning, an analyst at BDA China Ltd., told Bloomberg. "Piracy is getting better in China but will stay a problem in the short term."

For several quarters, Microsoft had been seeing a drop in piracy rates, which generally improved business in its Windows unit. However, the company saw an increased rate of piracy in the first quarter of 2008, Colleen Healy, Microsoft’s general manager of investor relations, told CNET News.com last month.

"Q3 was a tough quarter on the unlicensed front," she said. "We had been making gains there for the past several quarters."

To help combat the problem itself, Microsoft has begun experimenting with a Web-based application called Live Mesh, which gives users access to software over the internet. Software offered online is more difficult to copy and therefore less susceptible to piracy, BDA’s Liu said.

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Shares of Yahoo! Inc. (YHOO) tumbled 15% yesterday (Monday) to close at $24.37 a share as investors responded to Saturday’s news that Microsoft Corp. (MSFT) would drop its $47.5 billion dollar bid for the beleaguered search engine firm.

But the tough times are just beginning for Yahoo, which must now prove why it is worth more than the lofty price Microsoft was offering.

"Yahoo is going to be under a lot of pressure," Peter Falvey, managing director at technology-merger adviser Revolution Partners, told Bloomberg News. "A lot of shareholders are going to say, ‘Hmm, maybe we overreached.’"

Microsoft originally offered $31 per share in either cash or Microsoft stock, a 62% premium to Yahoo’s Feb. 3 closing price. It boosted the bid to $33 a share, appraising Yahoo at approximately $47.5 billion, but Yahoo refused to accept anything less than $37.

Now, at $24 a share, Yahoo as a company is only worth about $33.5 billion.

That means Jerry Yang, Yahoo’s co-founder and chief executive, has the unenviable task of delivering better performance after Yahoo’s bold reprisal. In short, he’ll have to add at least $14 billion in market value to the company if he’s going to justify his decision and prove that rejecting Microsoft’s offer was the right move.

And one doesn’t have to take a very long look at Yahoo to see Yang has his work cut out for him.

Why Yahoo! Isn’t Worth $37 a Share

Last month, Yahoo reported a first-quarter profit of $542 million, or 37 cents per share, up from $142 million, or 10 cents per share last year. It was the company’s first profit increase in nine straight quarters (more than two years). But a big reason for the jump was a one-time gain of $401 million – a windfall from the sale of Yahoo’s stake in Alibaba.com Ltd.’s (PINK:ALBCF), which came from the Asian Internet company’s initial public offering (IPO).

Excluding one-time items, Yahoo reported earnings of 11 cents a share.

Even with the profit increase, the company continued to lose market share to nemesis Google Inc. (GOOG), the leader in Internet search. Yahoo accounts for 21.3 % of all U.S. searches according to comScore Inc. 

That compares with a near 60% sway for its rival, Google, which defied Wall Street’s first-quarter expectations by expanding its revenue nearly four times faster than Yahoo. While Yahoo’s sales climbed 14% last quarter, Google posted a 46% jump in revenue.
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In April, Yahoo all but acknowledged Google’s victory by outsourcing a small portion of its search advertising to its competitor on a two-week trial basis. If Yahoo continues using Google’s search advertising system, it will be abandoning its own "Panama" ad system. Launched in February, the Panama initiative set the company back millions of dollars. Even so, it continues to lag behind Google’s AdSense in terms of revenue per search query.
As it worked to bulk up its search capabilities, Yahoo had earlier shelled out $1.63 billion for Overture Services and $235 million for Inktomi. That’s close to $2 billion for search engine service specialists that would for, all intents and purposes, be rendered moot should Yahoo ultimately outsource even more of its search-related business.

While some analysts believe a bigger deal with Google may already be in the works, any serious collaboration between the United States’ two largest web portals would very likely run afoul of U.S. antitrust restrictions. Google already places ads on more than 67% of searches. The addition of Yahoo would expand its influence to 89% of searches, according to statistics from Hitwise. Microsoft said last month that Google would command more than 90% of the search advertising market.

"While Yahoo may pursue a Google search partnership as a way to appease shareholders through enhanced cash flow, we believe such a deal would face intense anti-trust scrutiny," Clayton Moran, an analyst with Stanford Group Company, told IDG News Service. "In addition it would cede control of search to Google."

Moran does not believe Yahoo’s stock will reach the $37 a share value over the next 12 to 18 months.

There have also been rumors that Yahoo will join forces with Time Warner Inc.’s (TWX) AOL or News Corp.’s (NWS) Fox Interactive Media business units. According to the details that have emerged so far, Time Warner would merge a large portion of AOL’s operations with Yahoo and make a cash investment in exchange for a 20% stake in the resulting company. Yahoo would use that cash infusion to buy back some of its own stock.

However, when it comes to Web-search market share, AOL currently ranks fourth, behind Google, Yahoo and Microsoft. So the company that emerged from that combination would be more of a content player than it would be a competitive Web-search firm.

Regardless of what Yahoo does to try to validate its decision to rebuff Microsoft, investors are already working themselves into an apoplectic frenzy over the move. Some Yahoo shareholders had already sued the company’s directors even before Microsoft decided to walk.

Enraged Yahoo shareholder Eric Jackson said Sunday that he planned to rally shareholders to withhold their votes from all Yahoo directors at the company’s annual meeting, which has not yet been scheduled. Jackson leads a group of about 140 shareholders who together own 2 million Yahoo shares.

"Significant value was left on the table," said Jackson, who heads a group of irate investors who together own about two million Yahoo shares.

Microsoft’s Next Move

In an ironic twist, Microsoft – like Yahoo – must now answer to a less-than-thrilled constituency.

Microsoft Chief Executive Steve Ballmer said April 24 that his company was willing and able to walk away from its bid for Yahoo.

"We’re prepared to move forward without a merger with Yahoo," Ballmer said at a technology conference in Italy. "We think the best way to move forward quickly is to come together with Yahoo. Hopefully that works. But if it doesn’t, we go forward. Time is money."

He lived up to his word Saturday, scrapping his company’s a $47.5 billion offer that valued Yahoo shares at a 70% premium to their January value after three agonizing months.

But now the man in charge of Microsoft must explain how the company plans to improve its eroding Internet business – which lost $228 million in the first quarter alone – without Yahoo.

Instead of the stock-price rally that many companies enjoy when they walk away from costly deals, Microsoft’s shares closed the day yesterday at $29.08, down 16 cents – hardly the vote of confidence the company would have wanted to see.

Since the company obviously has plenty of cash on hand, it may be a good idea to seek out a more agreeable partner.

"I’m looking for Microsoft to get aggressive with a buying spree," Gartner analyst Allen Weiner told IDG. "I think Microsoft should do something quickly to show the world that [the] Yahoo bid wasn’t a setback."

The company could try to strike a deal of its own with Time Warner or News Corp., or perhaps even with the trendy Facebook.com. Other analysts suspect Microsoft may be beckoned back to Yahoo’s rescue if the company fails to right its course by year’s end.

"Should Yahoo miss expectations in 2008, we would not be surprised to see MSFT come back to the table," RBC Captial analyst Ross Sandler said in a report yesterday morning.

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Microsoft Corp. (MSFT) last Saturday yanked its $44.6 billion bid for struggling Internet-search pioneer Yahoo! Inc. (YHOO) after the two companies were unable to come to terms over the buyout price.

In a statement, the software giant said it failed to win over Yahoo’s board of directors – even after boosting its bid by $5 billion. To move forward from here would require a shift into hostile mode, Microsoft said, a time-consuming and uncertainty filled process that would make Yahoo "undesirable as an acquisition candidate."

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"After careful consideration, we believe the economics demanded by Yahoo do not make sense for us, and it is in the best interests of Microsoft stockholders, employees and other stakeholders to withdraw our proposal," Microsoft Chief Executive Officer Steven A. Ballmer said in a statement.

It’s only been three months after heavyweight Microsoft launched its half-stock, half-cash buyout offer for Yahoo, offering a 62% premium over Yahoo’s market price. Microsoft had offered to boost its bid for Yahoo from $31 a share to $33 a share – adding that afore-mentioned extra $5 billion.

Unfortunately for Microsoft, even that higher price was nowhere near the $37-a-share offer that Yahoo co-founder and CEO Jerry Yang said it would take to get the deal done.

The details of the negotiations were contained in a letter that Ballmer sent to Yang; Microsoft released the letter to the media over the weekend. According to the letter, that extra $4 per share would have increased the cost of the deal by another $5 billion – bringing the total to nearly $55 billion.

Yahoo rejected Microsoft’s first $44.6 billion takeover offer Feb. 11, saying the bid substantially undervalued the company’s worth. The $31-per-share offer valued Yahoo at a 62% premium on Feb. 1, but Yahoo has traded as high as $31 a share as recently as November. Yang feels Yahoo is worth more than Microsoft is offering, even though the $33 per share offer is only about a dollar off of Yahoo’s 52-week high of $34.08.

Yahoo has consistently been losing market share to Google Inc.’s (GOOG) market dominance and tried to engage a number of other competitors such as Time Warner Inc. (TWX) and News Corp. (NWS) about possible partnerships, but with little success.

"This process has underscored our unique and valuable strategic position," Yang said in the statement, MarketWatch reported. "With the distraction of Microsoft’s unsolicited proposal now behind us, we will be able to focus all of our energies on executing the most important transition in our history so that we can maximize our potential to the benefit of our shareholders, employees, partners and users."

As late as Friday, Yahoo shares jumped 7% with a gain of $1.86 to close at $28.67 on reports of "intensifying" talks with Microsoft and an expected deal. But with the announcement on Saturday, some analysts feel the formal rescinding of the offer and the fact that Microsoft seems unwilling to resort to a proxy contest could put downward pressure on Yahoo shares, sending the stock back down towards its 52-week low of $18.58. If that happens, Yang and Yahoo’s board of directors could find themselves with a slew of lawsuits filed by angry Yahoo shareholders.
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Earlier this month, Micorsoft Corp. (MSFT) announced its second "Fair Play Day" in 14 Latin American countries, where investigations led to the seizure of more than 160,000 counterfeit copies of Microsoft software. The contraband had an estimated street value of $18.2 million.

This is just the latest attempt by the software giant to try to stem the rising tide of counterfeit products that costs the company millions of dollars annually in some of its most promising markets.

"The crackdowns are part of Microsoft’s global Genuine Software Initiative, which aims to help protect legitimate distributors and customers from the effects of software piracy," said Microsoft SA partner executive Mark Reynolds.

Microsoft is also trying to protect its bottom line, which has been sharply undermined by the rise in piracy.

For its fiscal third quarter ended March 31, Microsoft net income fell 11% to $4.39 billion, or 47 cents a share, mostly the result of a 24% drop in sales for the company’s flagship Windows software.

Microsoft’s general manager of investor relations, Colleen Healy, attributed much of the sales decline to the cottage industry that has sprouted around an upswing in the number of unlicensed PCs on the market. 

"Q3 was a tough quarter on the unlicensed front," Healy told CNET. "We had been making gains there for the past several quarters."

The company made special notice of it in its fiscal third-quarter earnings, released Friday:

"While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly in countries where laws are less protective of intellectual property rights. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights," the company said.

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Skeptics of the growing piracy epidemic may find it difficult to empathize with Microsoft, a $276 billion company with its own legacy of piracy dating back to the company’s founding. But the black-market distribution of counterfeit software is also a hurdle for emerging economies by siphoning off tax revenue and strangling legitimate software retailers.

Arrgh-dent Piracy Concern

Software piracy is so widespread in South Africa, it’s almost thought of as commonplace rather than illegal.

A 2006 piracy study by IDC – a technology and telecommunications advisory firm – found 35% of the software in South Africa is illegal, costing software publishers more than $150 million a year in that country alone.

"Piracy remains one of the major hurdles to realizing the potential of the information economy in South Africa and on the continent," Business Software Alliance SA Chairman Alastair de Wet told IT Web. "There is great concern for our local economy that over a third of software in use is illegal."

Indeed, South Africa’s IT industry employs more than 355,000 people and for every rand that Microsoft earned last year, partners working with Microsoft would have earned 9.69 rand, de Wet said.

But Microsoft is not one to stand on the sidelines. To continue its pursuit of protection, Microsoft has launched the Genuine Software Initiative.

"We want to protect legitimate computer businesses and resellers who do the right thing in selling genuine software," Microsoft’s Reynolds told IT Web. "Microsoft won’t stand by and allow unscrupulous vendors to destroy the businesses of our channel partners or the jobs of their employees."

Earlier this month, Microsoft settled out of court with 21 South African computer dealers that were selling computers loaded with unlicensed Microsoft software.

And last week in China, police broke up a piracy ring in Shenzhen, seizing programs worth upward of $750 million on a tip from the Federal Bureau of Investigation.

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Over the past several days Yahoo! Inc. (YHOO) and Microsoft Corp. (MSFT) have reached a critical impasse in takeover negotiations. Ultimately, to make a deal, Microsoft might be forced to take its offer directly to Yahoo shareholders in the form of a proxy contest, or simply raise its offer to lure Yahoo to the negotiating table.

Yahoo rejected Microsoft’s $44.6 billion takeover offer Feb. 11, saying the bid substantially undervalued the company’s worth. The $31-per-share offer valued Yahoo at a 62% premium on Feb. 1, but it should also be noted that Yahoo traded at $31 a share as recently as November. In its statement Yahoo also said it was worth more because of recent acquisitions, technological developments and the firm’s investment portfolio.

Since then, Yahoo has engaged a number of other competitors such as Time Warner Inc. (TWX) and News Corp. (NWS) about possible partnerships, but with little success. Microsoft, eager to challenge Google Inc.’s (GOOG) market dominance, has grown impatient and Saturday threatened to take its case directly to Yahoo’s shareholders.

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In a letter to Yahoo’s brass, Microsoft Chief Executive Officer Steven A. Ballmer expressed his disappointment with what he perceives as a lack of cooperation.

"It has now been more than two months since we made our proposal to acquire Yahoo! at a 62% premium to its closing price on January 31, 2008, the day prior to our announcement," Ballmer wrote. "Our goal in making such a generous offer was to create the basis for a speedy and ultimately friendly transaction. Despite this, the pace of the last two months has been anything but speedy."

Ballmer pointed out that economic conditions have deteriorated since February, as have Yahoo’s web traffic and market value, making now the time to negotiate a definitive agreement.

"If we have not concluded an agreement within the next three weeks, we will be compelled to take our case directly to your shareholders, including the initiation of a proxy contest to elect an alternative slate of directors for the Yahoo! board," Ballmer wrote.

"That action will have an undesirable impact on the value of your company from our perspective, which will be reflected in the terms of our proposal," he added.

Yahoo responded yesterday (Monday), emphasizing in a letter to Ballmer that it does not oppose a transaction with Microsoft, so long as the offer fully reflects the value of Yahoo. Chief Executive Officer Jerry Yang and Chairman of the Board Roy Bostock, who penned the letter, also rejected Ballmer’s assertion that business has deteriorated.

"Contrary to statements in your letter, stockholders representing a significant portion of our outstanding shares have indicated to us that your proposal substantially undervalues Yahoo," they said.

"We are steadfast in our commitment to choosing a path that maximizes shareholder value, and we will not allow you or anyone else to acquire the company for anything less than its full value."

Yang and Bostock also characterized the threat of a proxy contest to displace independent board members as "counterproductive and inconsistent with [the] stated objective of a friendly transaction."

"We are confident that our stockholders understand that our independent board is best positioned to objectively and knowledgeably evaluate our company’s alternatives and to maximize value," the letter continued.

Microsoft insists there is no reason to raise its bid because Yahoo has no competing offers, but it may be forced to do just that if it wants to avoid the fiscal and social costs associated with a proxy contest.

"Microsoft doesn’t want to spend a year negotiating, playing cat and mouse with the Yahoo board and another year to close this transaction to get all the regulatory approvals," Colin Gillis, an analyst at Canaccord Adams, told Bloomberg.

Yahoo has not yet announced the date of its next shareholders’ meeting. All 10 of the company’s board members will be up for re-election. The last meeting occurred June 12, and under Delaware law, the company must hold one every 13 months.

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Yahoo! Inc. (YHOO) formally rejected Microsoft Corp.’s (MSFT) $44.6 billion takeover offer, yesterday (Monday). At the same time, speculation involving possible tie-ups with other industry leaders such as Time Warner Inc.’s (TWX) AOL and Google Inc. (GOOG) resurfaced.

After 10 days of review, Yahoo’s board unanimously decided that the $31 pershare offer, "substantially undervalues" the company. Yahoo didn’t name a figure the company brass would deem acceptable but many analysts believe it should be around $40 a share.

Microsoft’s offer valued Yahoo at a 62% premium on Feb. 1, but it should also be noted that Yahoo traded at $31 a share as recently as November.  In its statement Yahoo also said it was worth more because of recent acquisitions, technological developments and the firm’s investment portfolio.

"Yahoo thinks [it's] worth more because of the plans [it has] implemented that have yet to come to fruition," Daniel Taylor, an analyst at Boston-based research firm Yankee Group, told Bloomberg News. "The board is saying ‘We think we can keep the company together and do far better with it than Microsoft ever will.’"

Soon after the rejection, the Times of London reported that Yahoo had engaged in merger talks with AOL, Google and Walt Disney Co. (DIS). The paper did not identify the source of the information. 

Time Warner announced last week that it planned to break AOL’s Internet access business apart from its Web portal and advertising business. While AOL’s Internet access business has struggled, the company’s Internet content and online advertising business could be a good fit. AOL owns such web sites as MapQuest and TMZ. It also owns several advertising technology firms.

Talks between Yahoo and AOL faltered last year because of differences over price, the Times of London said. Also, any takeover attempt from Yahoo that valued AOL at more than $20 billion would also benefit rival Google, which purchased a 5% stake in the company in 2006.

Meanwhile if Yahoo were to make a deal with Google directly, it’s likely the merger would come under intense regulatory scrutiny, as the resulting venture would control nearly three-quarters of U.S web-search traffic.

While it’s certainly feasible that other parties are interested in working with the embattled Yahoo, the possibility that the company is just trying to extract a higher premium from Microsoft before folding cannot be ruled out.

Last week, in a note to clients, Citigroup Inc. (C) analyst Mark Mahaney said that it is reasonable to assume that Microsoft will be willing to increase its offer in coming weeks.

"In a hostile deal, the acquirer usually does not lead with its best and final offer and we would not be surprised to see Microsoft sweeten the pot somewhat to make the decision easier for Yahoo’s board," the note said.

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Yahoo! Inc. (YHOO) is still examining Microsoft’s (MSFT) unsolicited $44.6 billion takeover bid, and weighing its options.

In an e-mail to employees, Chief Executive Officer Jerry Yang said the company had a "wide range" of options to consider before pursuing its "transformation strategy." However, in a note to clients, Citigroup Inc. (C) analyst Mark Mahaney said that it is reasonable to assume that Microsoft will be willing to increase its offer in coming weeks.

"In a hostile deal, the acquirer usually does not lead with its best and final offer and we would not be surprised to see Microsoft sweeten the pot somewhat to make the decision easier for Yahoo’s board," the note said.

According to Citi, there is a 40% chance that Microsoft will raise its bid if Yahoo! rejects its initial offer. The bank gives a 20% probability that Yahoo! will accept the current bid as is, and a 25% chance that that Yahoo will hire Google (GOOG) to run its web search operations. Yahoo! may also solicit rival offers from Rupert Murdoch’s News Corp. (NWS) or Comcast Corp. (CMCSA)

Microsoft made an offer of $31 a share to Yahoo! last week in hopes of uniting the second and third-largest search providers to take on Google, which has a commanding share of the market.

Google drew 56% of U.S. web search traffic in December, nearly double the combined share of Yahoo! and Microsoft, which attracted 18% and 13%, respectively.

Microsoft expects that in taking over Yahoo!, it will benefit from economies of scale in the online advertising market, as well as greater operational efficiency, and the pooling of engineering and creative talent.

Citi said that Microsoft is eager to siphon off Yahoo’s Internet advertising abilities, and that those synergies would ensure the deal’s value even at a higher bid.

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Google Inc. (GOOG) didn’t waste any time before weighing in on Microsoft Corporation’s (MSFT) takeover bid for Yahoo! Inc. (YHOO). Google officials lashed out against Microsoft’s supposed motives yesterday [Monday], and even offered to help Yahoo! rebuff the takeover through a partnership of its own.

"While the internet rewards competitive innovation, Microsoft has frequently sought to establish proprietary monopolies – and then leverage its dominance into new adjacent markets," Google’s top lawyer, David Drummond said in a posting on the company’s blog.

The International Herald Tribune cited sources familiar with Google’s operations as saying that company lobbyists are already appealing to lawmakers in Washington in an effort to stall or derail the deal.

Google Chief Executive Eric Schmidt also reportedly made a call to Yahoo’s CEO Jerry Yang and offered his company’s assistance in fending off the bid. Several other Google executives made "back channel" calls to companies such as Time Warner Inc. (TWX), owner of AOL, to determine whether a rival bid was planned.

Few analysts believe a bidding war with Microsoft is likely because the company has such deep pockets. Microsoft had $21.1 billion in cash and short-term investments as of Dec. 31. The company may be forced to borrow money for the first time ever to finance its proposed $44.6 billion takeover. Microsoft has proposed paying half of the offer with stock and the other half with cash.

Still, Yahoo insists that it has received calls from a number of suitors over the weekend. A tie-up between Google and Yahoo is not out of the question either. Talks between the two search engines stalled last year, but Yahoo may find more favorable terms if it aligns itself with its former rival now that Microsoft is in play.

Microsoft has done its best to deflect criticism.

"The combination of Microsoft and Yahoo will create a more competitive marketplace by establishing a compelling No. 2 competitor for Internet search and online advertising," Microsoft’s general counsel, Bradford L. Smith, said in a statement. 

It’s a fair point considering Google drew 56% of U.S. web search traffic in December, nearly double the combined share of Yahoo and Microsoft, which attracted 18% and 13% of the market, respectively.

However, Microsoft’s reputation as a borderline industry thug is working against it.

"Google can tap into all of the ill will that Microsoft has created in the last couple of decades on the antitrust front," Eric Goldman, director of the High-Tech Law Institute at Santa Clara University School of Law told IHT.

But Microsoft isn’t the only company accused of antitrust issues. Google did its share of feather rousing last April when it bid $3.1 billion for online advertising specialist DoubleClick.

"This proposed acquisition raises serious competition and privacy concerns in that it gives the Google DoubleClick combination unprecedented control in the delivery of online advertising, and access to a huge amount of consumer information by tracking what customers do online" Microsoft’s Smith said in a statement. "We think this merger deserves close scrutiny from regulatory authorities to ensure a competitive online advertising market."

Here are the top five technology deals involving Silicon Valley companies over the past five years, including Friday’s proposed acquisition of Yahoo by Microsoft.

Footnotes: (1.) Value When Announced.

Sources: Bloomberg News, San Jose Mercury News, Money Morning Research.

[For further analysis on Microsoft Corp's attempted takeover of Yahoo Inc click here]

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With its $44.6 billion hostile bid for Internet search pioneer Yahoo! Inc. (YHOO), software giant Microsoft Corp. (MSFT) is poised to redefine the deal-making market.

According to an analysis of the deal conducted by the San Jose Mercury News, this is more than just a simple acquisition: The hostile buyout bid confirms Google Inc.’s (GOOG) dominance of the Internet search-and-advertising markets, even as it underscores Google’s stranglehold dominance on both of those high-tech venues.

It also stands as the best evidence yet that Microsoft is no longer the feared behemoth that ruled whatever market niche it entered, and that was able to dictate standards throughout the high-tech sector.

Google’s lead in the all-important Internet search arena is so commanding that Microsoft and Yahoo can only hope to give it a run by combining forces – even though Yahoo remains the single-most-visited Web site in the world.

After spending millions in a vain attempt to establish itself as the leader in Internet search, Microsoft has abandoned its "go-it-alone" strategy, believing that after forming a dynamic duo with Yahoo, together they can achieve what it wasn’t able to do while flying solo.

But this strategy – which an advertising executive somewhat derisively dubbed the "one plus one equals three" approach – may not be a panacea, either, for some real challenges remain. Just getting the deal done could be an unachievable objective. Only time will tell.

For now, here are some of the challenges that a Microsoft-Yahoo linkup faces:

• Antitrust issues could easily take two years to work out.

• A corporate culture class between the work forces of Microsoft and Yahoo could mute the merger’s benefits – assuming the deal even gets done.

• Regulatory approvals won’t be easy to get, especially since most government bureaucrats still view Microsoft as the powerhouse it once was, and don’t see the nuances that have caused its market power to ebb.

And there’s one other key point to consider: If any of these obstacles prove problematic – that is, if the Microsoft-Yahoo marriage gets bogged down in negotiations, regulatory approvals, or as an ultra-messy integration – the real beneficiary of this buyout could be Google. As the merger gets drawn out, it could become a major management distraction that allows Google to enhance its already large lead.

Let’s consider a few of these issues, as well as the catalyst for the deal, itself.

The Allure of the Deal

During a conference call late last week, Microsoft Chief Executive Officer Steven A. Ballmer said that, "when you combine the strengths of our two companies, the result will be an incredibly efficient and competitive offering for consumers, for advertisers and for publishers."

After first approaching Yahoo concerning a merger about a year ago, Ballmer said he finally called Yahoo CEO and co-founder Jerry Yang last Thursday to tell him Microsoft was launching the bid.

For Microsoft, the attraction is that the two companies compete in three key areas. Presumably, the software giant’s leaders believe that by combining these capabilities, a stronger enterprise will result.

Among those businesses, the key one is Internet search: At the beginning of last year, Yahoo controlled 26.9% of this market, and Microsoft 10.4%. Google carried the day with a mammoth 52.6%, according to high-tech researcher comScore. But by December, Yahoo watched its market share slip to 22.4%, while Microsoft skidded to 9.8%. Google gobbled up what those two lost and more besides, picking up six percentage points to control 58.6% of the market. 

So even if the merger goes through, the market’s No. 2 and No. 3 companies would merge to create a larger No. 2 that’s still only about half the size of Google in terms of Internet search market share.

Yahoo bills itself as being the "most visited site on the Web." By the end of last year, however, Google had leapfrogged both the Microsoft and Time Warner sites to take the second spot behind Yahoo, on which it also markedly closed the gap.

Antitrust Issues

Microsoft predicted – quite confidently – that it would get federal approval for the Yahoo deal this year. The deal also will have to gain the approval of shareholders.

Analysts who follow the industry say that antitrust issues will take two years to work out, especially since Yahoo Mail and Microsoft’s Hotmail account for 95% of the Web mail market.

Microsoft can expect a review by the U.S. Department of Justice, the Federal Trade Commission – or both. And the European Commission will definitely scrutinize the deal.

The potential obstacles include:

• Concerns that the buyout would give Microsoft most of the market for Web-based e-mail and instant messaging, making it the key Internet gatekeeper.
• Worries about privacy, given the increasingly powerful feature sets that Internet search engines contain.
• A concern that if Microsoft bundles Yahoo’s portal with such services as e-mail that it will be able to regain the market-controlling high ground it possessed a decade ago.

If it takes a year for federal regulators to approve the deal, that approval process could get pushed into the next administration, making it a big wild card. The Bush administration has been fairly lenient in approving big mergers, but there’s no guarantee the next administration would feel the same way.
Google, too, could raise antitrust concerns, but most experts say the company will have to tread lightly.

But it may not have to worry: Congress could play that very role. Congress has already announced it would hold antitrust hearings on the Microsoft-Yahoo bid, with House Judiciary Chairman John Conyers Jr., D-Mich., and ranking Republican Lamar Smith, R-Texas, stating in a joint statement Friday that the proposed deal raises "competitive issues," according to a report by Information Week.

In the end, the deal will probably be allowed to go through. Unless the government can prove that someone will offer more, or will do a better job running Yahoo, which is a company in decline, "it’s going to be hard to get the government to launch a thousand ships to stop the deal," Gary L. Reback, of Carr & Ferrell in Palo Alto, told the Mercury News.

Culture Clash

Whether Microsoft executives will publicly admit this is a whole different story, but analysts say that the company will face huge challenges in its efforts to meld the two corporate cultures. While both are ostensibly high-tech firms, Yahoo is essentially a Silicon Valley-based media company, while Microsoft is an engineering-focused software firm that operates in the relative isolation of Washington state – far from the influences of Silicon Valley.

As one media report noted, employees at Yahoo work in cubicles – the norm in fast-paced Silicon Valley – while offices are de rigueur at Microsoft.

The track record for successful integrations in the Internet sector is not great, with the badly miscalculated AOL Time Warner [Time Warner Inc. (TWX)] deal serving as a case in point. Exacerbating that concern is the reality that Microsoft has little experience with big acquisitions – and this one is massive, and will take years to make work.

The key issues:

• What will become of such key branded products as Yahoo, MSN and Windows Live, or the overlapping properties, such as MSN Money and Money and Yahoo Finance, or Yahoo Mail and Hotmail?

• Will it be possible to combine the different technologies that sit behind and power these key products, since the technology and the products together create the value Microsoft is buying and hopes to extract?

• Who will lead the combined Web division?

• And, most of all, will Microsoft be able to minimize or even eliminate the clash between employees and managers who come from two very different corporate cultures?

Microsoft contends it already is working this out. But the company literally took years to integrate Great Plains Software and Navision, even though both had Microsoft-friendly technology and were a fraction of the size of aQuantive – a $6 billion deal that’s Microsoft’s biggest to date, analysts say. And it’s too early to tell how it’s done with its buyout of aQuantive last year.

The industry doesn’t have a great track record when it comes to integrating new properties. Internet-search-engine-pioneer Netscape virtually disappeared after it was bought by America Online, which, in turn, lost market share and importance after it was bought out by Time Warner. And Yahoo stumbled in its attempt to integrate Overture, an Internet firm it bought in 2003.

One other thing: With a high-tech company, the most-valuable assets of all are able to walk out the door at the end of each day. To really get full value, Microsoft has to persuade Yahoo employees to stick around after the deal closes.

None of these challenges are insurmountable. And Microsoft has billions of dollars in cash to throw at any problem.

Lastly, Microsoft seems to understand that this deal is crucial to its ability to finally reposition itself into a position of importance in the Internet sector.

"It’s going to be hard. There are going to be some rough spots. But eventually, it’s going to work out," Karsten Weide, an analyst with the market researcher IDC, said in an interview over the weekend

Could Google be the Big Winner?

As this all plays out, Microsoft has to be very careful that the deal doesn’t serve to lengthen Google’s already-big lead.

For one thing, many analysts are criticizing Microsoft’s strategy by alleging that the deal, as proposed, does almost nothing to attack Google’s ever-expanding Web dominance.

Indeed, in an ironic twist, it may well be Google – which some analysts have nicknamed "The Mighty Mammoth of Mountain View" – that ends up as the biggest winner from a Microsoft-Yahoo merger.

While the new company – which one industry wag says could be named either Microhoo or YahooSoft – would have more Web traffic than Google, there’s a problem. Right now, Yahoo has an edge with display advertisers, so the traffic boost should give the newly combined firm a real boost.

But if it takes two years to get the deal approved, and another two to get the merged entity straightened out, any advantages that the Microsoft-Yahoo alliance brings to the table could well evaporate.

Google has already leapt into the wireless phone market, striking global deals and promoting an open handset standard. The firm is even looking to wager billions to buy U.S. wireless spectrum to launch its own wireless voice-and-data services business.

Competitive Advantages

All is not lost. With its top-rated consumer Web portal, My Yahoo, Yahoo still boasts tens of millions of loyal users. Microsoft’s operating systems still run 90% of all desktop computers and a big percentage of the servers that manage the Internet.

If Microsoft could pick the best products, services and technology from each company, and do so quickly and efficiently, it could assemble a powerful PC-and-Internet venture.

But as one columnist noted, at its press conference, Microsoft sounded more like it was talking about the steel industry than anything related to software, the Internet or technology. Microsoft execs emphasized the "economies of scale" offered by the deal, referring to savings on research & development, equipment and labor.

Google, however, is a brand. And, as a company, it is both innovative and relentless. It started out offering a simple search service, and has continued to add products and features that have secured its market position and increased its market power.

At the end of the day, the big question to be answered about the Microsoft-Yahoo deal isn’t whether it will happen, or even when it will happen. For it’s very likely it will come to pass.

The real question is whether it will work – and whether Microsoft has the ability to make it work.

[Editor's Note: For the latest developments in the Microsoft-Yahoo buyout battle - including Google's potential intervention - in today's issue of Money Morning, please click here].

News and Related Story Links:

• Information Week:
  Congress to Hold Antitrust Hearing on Microsoft’s Yahoo Bid

• San Jose Mercury News:
  Microsoft’s bid for Yahoo: Would it work vs. Google?

• Money Morning:
  Microsoft Launches $44.6 Billion Hostile Buyout Bid for Search Pioneer Yahoo!

• San Jose Mercury News:
  Is Microsoft bid for Yahoo a culture clash in the making? There are "Messy" Issues in an Acquisition

• San Jose Mercury News:
  Antitrust approval for Yahoo deal may not be a slam-dunk