Would a Microsoft-Yahoo deal out Google Google?

Bid is riddled with pitfalls and benefits, analysts say

As Microsoft Corp. tries to take on search company Google Inc. for more advertising revenue by offering to acquire Yahoo Inc., a big question remains: Can Microsoft and Yahoo together best Google?

"That's the key question," said Allan Krans, an analyst at Technology Business Research Inc. in Hampton, N.H. "I think it puts them in a better position to gain ground on Google, but I think it's far from any guaranteed results."

Microsoft today announced an unsolicited $44.6 billion cash and stock offer to buy Yahoo to create an alternative to the Google juggernaut. Yahoo said it's reviewing the offer and will respond later.

Several analysts interviewed today said the deal has more than its share of benefits and pitfalls for both companies. If Microsoft succeeds in acquiring Yahoo, then the two companies' next step should be to "lay out a strategy to drive search," Krans said. "The ultimate goal is to drive online advertising revenue, but to get there you have to have tools and the platform. But then what advertisers really want to see is people clicking on your site."

Herein lies the problem for both Microsoft and Yahoo: More Internet users go to Google for their online searches than either Microsoft's or Yahoo's Web sites. "They haven't been successful at capturing more of that online traffic. They're going to have to turn that around. They're also going to have to attract more advertisers," Krans said.

A benefit of such a deal, however, is that instead of continuing to compete with each other while attempting to catch up with Google, Microsoft and Yahoo could combine their best features and try to gain ground on Google as one, Krans said. "Microsoft is trying to drive the popularity of its Windows and Office tools through their online offerings, while Yahoo has popular e-mail services and strength in its [online user] groups. Once people sign up and participate in those groups, it tends to be a very sticky thing. People don't jump around."

Could such an acquisition help Microsoft catch Google?

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

"I think it's going to take a long time," Krans said. "At this point, both companies would like to stop the erosion of their market shares and retain their bases because it just keeps flowing over to Google. Either way, it's going to be a long-term strategy. Google has over a 60% share of search in the United States. It will take a while to change that."

Even if it acquires Yahoo, Microsoft has no way of knowing if it can get users to leave Google and do their searches with Microsoft-Yahoo, he said.

"How do you change what millions of consumers do in terms of their search?" he asked. "It's a very difficult proposition to change those user preferences. It's a difficult question to answer, but they're going to have to figure it out if they're going to challenge Google."

Ironically for Microsoft, the situation is similar to the one faced by a multitude of competitors that have tried over the years to take on Microsoft's Office productivity suite in the marketplace, Krans said. Microsoft Office is firmly entrenched and is used by millions, and competitors have yet to make a significant dent in its market position.

"How do you offer an alternative to Microsoft Office?" Krans asked. "They're facing the same type of challenge in facing off with Google. The tables are turned in that respect."

In a telephone conference call with financial analysts this morning, Microsoft said it wants to give users choice and stop Google from unfairly dominating the search marketplace.

Krans found that an interesting argument coming from Microsoft, since others have accused it of dominating operating systems and other software markets for some time. "Once the shoe's on the other foot, it's a different story," he said.

Rob Enderle, an analyst at San Jose-based Enderle Group, said the deal could change the stakes in the online search marketplace. "Microsoft's MSN property and Yahoo's online property together have enough power to provide a nice hedge against where Google is going," Enderle said.

But Google is likely to try to block the deal, first on antitrust grounds much like Microsoft moved against Google against DoubleClick Inc., Enderle said.

"And Google will try to outbid Microsoft," he predicted, "because neither one of these guys wants the other to get this property and so this is likely to be hard fought."

Google spokesman Matt Furman said his company would have no statement about the Microsoft offer. "It would be premature for us to comment at this time," he said.

Apple and oranges

Dana Gardner, an analyst at Interarbor Solutions LLC of Gilford, N.H., said the potential acquisition is a "risky bet" for Microsoft because the two companies have fundamentally different technological heritages. Microsoft is based on its Windows infrastructure, while Yahoo is built on open-source software and open standards and has even led the way in open-source circles on a variety of projects.

"Fundamentally, we've got apples and oranges for their infrastructures and their philosophies for how to approach software," Gardner said. In addition, Microsoft is fueled by revenue from software licensing while Yahoo revenues almost entirely come from advertising sales, while both companies have very different internal cultures, he said. "These are things that are going to take time" to resolve, he said. "Anytime a merger of this size, $45 billion, comes up, it's not good. Sometimes size is too much to overcome."

Another potential problem, he said, is that many corporate IT managers may worry about such an acquisition because it takes Microsoft's focus farther away from its longtime central role of providing needed software to corporations and consumers.

With this offer, "Microsoft is betting itself on search," Gardner said. "And if you're betting the company outside your normal area, then as a CEO [who relies on your software], that would leave me concerned."

The offer made today "does sort of smack of desperation," Gardner said. "It would have made more sense a few years ago to have done a merger with Yahoo, but this is an unsolicited bid. It really seems Microsoft waited for Yahoo to be on one knee [financially] in what needs to be a friendly acquisition" for it to succeed swiftly. "That's why I think its risky."

Where would the deal leave Microsoft?

"It's like a multiheaded dragon," Gardner said. "You don't really know what it is. As an IT buyer and user, you might not know what to expect from them in the future. Users want companies that are there for them. I think it's going to help IBM. I think it's going to help Apple. It helps muddy the waters in a way that Microsoft competitors can take advantage of."

Guy Creese, an analyst at Midvale, Utah-based Burton Group, said the offer comes from Microsoft as a response to a changing search marketplace. "It's not a knee-jerk reaction to it, but they are saying 'OK, how do we win?'"

Watch the data centers

One area to watch in the potential acquisition is what will happen if the two companies put their data centers together, Creese said.

"They both are building these big, whopping data centers," Creese said. Yahoo's is for user services such as e-mail and chat, and Microsoft is building data centers to support its Office Live capabilities. "If brought together, Microsoft would bulk up to probably twice the number of data centers" that it has today, putting it in a much more powerful position.

Another piece of the unfolding scenario to watch, Creese said, is how Microsoft would approach one of Yahoo's recent acquisitions -- the open-source Zimbra collaboration suite. "It's a nice [software-as-a-service] and software-based suite with a calendar and other parts. ... It would be very interesting if it would be added to the Microsoft portfolio. ... I think this is a jewel that Yahoo has that would be a very nice extra-credit sort of thing."

David Ferris, president of San Francisco-based Ferris Research, said the deal makes sense for Microsoft because Yahoo "has a certain strength in responsiveness to consumer needs that Microsoft has not had. And that I think would be one of the major synergies."

"I think that Google, to my mind, has not demonstrated the same level of user-friendliness and understanding as Yahoo," Ferris said.

While Microsoft prides itself on technological excellence, Yahoo prides itself on being an organization with a goal of bending technology to enhance the lives of consumers, Ferris said. "The combination of those two -- bringing Yahoo's skills and positioning brings significance to Microsoft in its attempts to provide consumer services," he said.

Ferris said Microsoft's offer is reasonable but as a shareholder he wouldn't immediately jump at it. However, he said the deal offers many benefits to Yahoo. "This can help Yahoo with deeper pockets, it can help with all sorts of technology partnerships and it can revitalize Yahoo."

Copyright © 2008 IDG Communications, Inc.

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