Tough road for MSoft, Yahoo tie

New York - Yahoo's stock gains on Friday show that some investors like the idea of a Microsoft acquisition, but a deal is not assured.
A number of barriers are working against a deal, including Microsoft's historical reticence to large acquisitions, the risks of integrating two large operations and Yahoo's possible resistance to being absorbed by the Redmond, Washington, software giant.

As reported by The Wall Street Journal, Microsoft and Yahoo executives are taking a fresh look at a merger of the two companies or some kind of match-up that would pair their companies' respective strengths, according to people familiar with the situation.

However, the talks - rumours of which come and go - appear to be early stage, and their status is unclear. Indeed, one source close to Microsoft says talks are not underway currently.

Nonetheless, to many, a merger would create a more formidable competitor to Google, with a better shot at checking its growing dominance of internet advertising. While Microsoft has the most to gain from a tie-up, the company has historically been averse to large, tricky acquisitions.

Meanwhile Yahoo, with less to gain and more to lose, appears cool to the idea. Yahoo's shares, though, skyrocketed on Friday on the reports, trading as high as $33.61, before settling down to $30.94, up 9.8% on the day. Microsoft shares fell 1.4% to $30.52.

Barriers to a deal

History and the sheer size of any transaction work against a deal. Talks have been rumoured for more than two years without result, even though many have seen a tie-up as "a quick fix, and the only fix, to Microsoft's broken internet business," Piper Jaffray analyst Gene Munster said in a note on Friday. He gave a merger only 25% odd of success.

Microsoft's largest acquisition to date was Great Plains software, which it bought in 2001 for $1.1bn. Munster estimates Microsoft will have to pay at least $60bn to win Yahoo, which he believes will demand a price that reflects the accelerated growth in search advertising it expects to reap from the Panama upgrade. The New York Post reported deal talk at about $50bn, or approximately $35 a share.

Any price tag is likely to carry a lofty valuation for Yahoo, which already is pricier than Google. According to Factset Research, an offer of $35 a share, would value Yahoo at 62.5 times current year estimates, nearly double Google's multiple of almost 34 times earnings estimates.

Microsoft, though, may have to pay that amount in order to gain the scale necessary to catch Google on the web. Within Microsoft, the winds that helped derail talks last year may have shifted.

At that time, managers within Microsoft's online group pushed for the company to rely on its own online search and ad systems and not buy Yahoo. But several of the architects of those systems have since left the company.

Meanwhile, Microsoft Chief Executive Steve Ballmer is under pressure to complete an acquisition to boost the company online. Last month, Microsoft and others including Yahoo, lost the chance to buy DoubleClick when Google swooped in and bought the online-ad specialist for $3.1bn.

"Yahoo is the only game-changing acquisition for Microsoft," Goldman Sachs analyst Anthony Noto wrote on Friday. Microsoft needs scale in advertisers, which is typically driven by scale in search queries, which it has failed to achieve on its own.

"Only Yahoo (not DoubleClick or any other acquisition other than potentially eBay with 5 million sellers, all of which could be advertisers) has a large base of advertisers and searchers."

Microsoft handled only 10% of web searches in March, compared with 22% for Yahoo and 54% for Google, according to measurement firm Nielsen//NetRatings.

However, top Yahoo executives could be a big obstacle to any deal. Co-founder Jerry Yang, for one, has a reputation for disliking Microsoft and avoids using Microsoft products, says one person familiar with the matter.

Top Yahoo staff might leave if Microsoft acquired the company and triggered a vesting of their Yahoo options.

Overall, Yahoo feels that its recently overhauled strategy, including a new organisational structure, investments in social media and mobile services and strong recent momentum in inking partnerships, has positioned it to better compete and take advantage of the boom in online advertising.

It also fears a loss of flexibility and agility that could occur if it is swallowed up by the enormous Microsoft, which is involved in many large technology markets.

Fighting Google

Though the integration of the two companies' operations would be a daunting prospect, industry watchers say the two companies would do well to team up against Google.

Microsoft would bring to the table a richly funded and well-staffed search-engine technology effort that could in time counter Google's technical superiority there.

Meanwhile, Yahoo would supply stronger consumer web traffic and a formidable advertising operation - including a solid salesforce, larger base of advertisers and a strong set of advertising-related technologies in both the search and display arenas.

Yahoo also would give Microsoft other valuable internet businesses, from a leading local-search service to small-business services to the HotJobs employment site.

"Together they are a force to be reckoned with," says Ben Kirshner, chief executive of New York search-marketing firm, Elite SEM Inc. "Separate, Google is just laughing all the way to the bank."