Update: Microsoft offers to buy Yahoo for $44.6B

Software vendor hopes deal would help it further challenge Google in online services

Microsoft Corp. today offered to buy Yahoo Inc. for $44.6 billion in cash and stock to better compete with Google Inc. in the market for online services.

CEO Steve Ballmer made the offer in a letter to Yahoo's board of directors yesterday, telling the board that he would release the letter this morning.

On a conference call this morning, Microsoft's president of its Platforms & Services division Kevin Johnson called a combination of Microsoft and Yahoo a more "credible" alternative to Google in the online advertising and services market.

"By combining the assets of Microsoft and Yahoo, we can offer a more competitive choice for consumers, advertisers and publishers," he said.

The market for online advertising is increasingly dominated by one player, Microsoft said, and merging with Yahoo will allow it to offer a competitive alternative.

It was Yahoo's board that first approached Microsoft, in February 2007, according to Microsoft executives. But, Ballmer said, "a year ago, the Yahoo management team said it wasn't the right time" for such a deal.

Now, he added, a combination of the companies is needed to fight back against Google's market dominance. "This is a decision we thought about, and I personally thought about, very, very hard," Ballmer said. "The market continues to grow, and the leader keeps consolidating its position."

Johnson said that the search and online portal business requires "scale economics" to support the massive capital-equipment investments needed from a systems infrastructure standpoint, as well as the cost of research and development, engineering and support.

Currently, Johnson said, the market "is ruled by one" — i.e., Google. "The industry will be better served by having competition," he added.

Yahoo, in a statement, said its board will carefully evaluate Microsoft's proposal, which it described as unsolicited.

Search Market Share

  Searches (000) Share of Searches
Google 4,062,536 56%
Yahoo 1,273,688 18%
MSN/Windows Live 995,899 14%
Source: Nielsen Online, December 2007 report

Microsoft expects the market for online advertising to almost double in size over the next three years, from $40 billion in 2007 to $80 billion by 2010. A merger will allow the company to realize economies of scale and reduce capital costs as it addresses this market, it said.

"The combination of these two great teams would enable us to jointly deliver a broad range of new experiences to our customers that neither of us would have achieved on our own," said Ray Ozzie, chief software architect at Microsoft, in a statement.

Microsoft expects to cut costs by $1 billion a year by realizing synergies with Yahoo in four areas: obtaining economies of scale as its audience increases; combining its research and development efforts with Yahoo's to innovate faster; eliminating operational redundancy to cut costs; and pooling expertise to innovate in video and mobile.

The companies will work together to develop the merger plan, Microsoft said.

Microsoft intends to pay key Yahoo engineers and other staffers to stay following the merger.

The offer represents a 62% premium over Yahoo's closing price yesterday. Microsoft expects to receive all necessary approvals in the second half of this year.

Yahoo shares rose 56% to $29.95 in premarket trading this morning following the announcement, Reuters reported. U.S. stock index futures also jumped after the news was released.

Despite the potential for short-term gain, Yahoo, in its statement, said its goal will be to maximize long-term value for shareholders.

At this premium, even if Yahoo's top managers were opposed to the acquisition, Yahoo's board has an obligation to consider the offer on behalf of shareholders, said industry analyst Greg Sterling of Sterling Market Intelligence.

At the same time, now that Microsoft has made its move, it wouldn't be surprising to see other suitors jump in and make competing bids for Yahoo, Sterling said. Unless Microsoft were to run Yahoo like an independent unit, there would be significant areas of overlap that would need to be integrated.

"If Microsoft were to seek a more integrated company [with Yahoo], certain products or brands would be favored and others discontinued," Sterling said.

Still, a joint Microsoft-Yahoo would from Day One be a formidable player in display advertising and mobile Internet services, he said.

Ever since the first rumblings about a possible acquisition of Yahoo by Microsoft, events have gone downhill for Yahoo -- including several reorganizations and management shake-ups -- so the deal appears more plausible today, Sterling said.

At the same time, despite considerable investments, Microsoft hasn't made as much progress in search engine advertising and usage as it had hoped, he said.

A combined Microsoft-Yahoo would improve the companies' respective positions in the search market but still wouldn't top Google, which has a dominant lead both in search engine usage and advertising, he said.

Brad Smith, Microsoft's general counsel, said Google's market lead should prevent it from trying to best the buyout offer announced today. Google is "not in a position to do this" because of antitrust laws, Smith said — an ironic comment by a Microsoft executive, considering that company's ongoing antitrust issues in the U.S. and Europe.

Todd R. Weiss of Computerworld and Elizabeth Montalbano of the IDG News Service contributed to this story.

Copyright © 2008 IDG Communications, Inc.

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