Microsoft makes bid for Yahoo

$45 billion offered in cash and stock

By BEN FRITZ

Johnson

Microsoft is making a $45 billion bid to become the world’s biggest Web media player.

If last week’s unsolicited offer is accepted by Yahoo’s board, which most Wall Streeters and insiders at both companies say is likely, it would combine Yahoo and Microsoft’s MSN and Windows Live services into the Web’s largest portal by far. At the same time, it would significantly increase Microsoft’s resources to compete with Google in search and advertising.

That could have significant implications for showbiz marketers, who like to use the home page and entertainment properties of Yahoo and, to a lesser extent, MSN to launch movies and series, but are increasingly turning to Google’s search-related ad programs.

The buyout offer is also an admission by Microsoft that despite billions of dollars of losses, its online efforts in the past decade have been largely unsuccessful. In nearly every category -- search, entertainment, email, music, games and more -- it lags well behind Yahoo and, where it competes, eons behind Google.

In an effort to stand out, Microsoft has stepped up efforts in original programming and video in the past year, all to little effect.

On a conference call with analysts, president of platforms and services Kevin Johnson, who oversees the company’s Internet businesses, admitted that he hopes the deal will finally reverse that trend.

“We have been losing money,” he stated bluntly. “Our plan here would not be to lose money in the future.”

Only other major portal left if the acquisition went through would be AOL, which has struggled to find a successful strategy for the past few years. Web execs largely agreed that a Microsoft-Yahoo roll-up would increase the pressure on Time Warner to either sell AOL or invest in a complementary acquisition so it would have a chance of competing.

Microsoft and Yahoo combined would account for 15.6% of Internet visits, compared with 7.7% for Google, research firm Hitwise reported. But the main thrust of the deal isn’t to dominate the portal biz, where advertising growth has slowed.

“There’s still a role for ad-supported content portals, but that’s not where this business is going,” said one Microsoft exec. “We’re taking out a major competitor so we can focus on competing with Google in the search-advertising space.”

Hitwise found that in January, Google handled 66% of Web searches in the U.S. MSN and Yahoo together were responsible for 28%.

Ads related to search remain red hot and Google’s rise in the past few years as a result has been meteoric, with revenue up 51% in 2006 to $4.8 billion in the fourth quarter of last year. By contrast, Yahoo revenue was up 8% last quarter to $1.8 billion and Microsoft’s online services division revenue rose 38% to $863 million.

“Today, the market is increasingly dominated by one player,” Johnson told analysts on the call. “By combining the assets of Microsoft and Yahoo, we can offer a more competitive choice for consumers, advertisers and publishers.”

If Microsoft is even somewhat successful at challenging Google, it could be good news for traditional media companies that are spending more and more of their marketing dollars online.

“I think if you’re an entertainment company, you’ve got to say this is a good thing,” said one experienced media exec close to the deal. “Whether it’s Apple (in digital music) or it’s Google, having one dominant force in a space is not great.”

Not coincidentally, offer comes at a low point for Yahoo, as the Web portal has been struggling to revive its fortunes in the face of intense competition from Google and Facebook and a number of internal shake-ups.

Last summer, Terry Semel ankled his CEO post amid investor unhappiness. On Wednesday, the day before Microsoft’s bid came in, he also resigned from Yahoo’s board. It’s not clear if there was a connection.

Rumors about a potential Microsoft-Yahoo combo have existed for several years. Microsoft CEO Steve Ballmer said his company has been in discussions with Yahoo for 18 months. About a year ago, Semel and other Yahoo execs rebuffed a potential offer that was almost certainly significantly more than the one tendered last week.

In his letter sent to the Yahoo board last Thursday, Ballmer said Semel wrote to him last February that Yahoo wasn’t interested in an acquisition because the board has confidence in the “potential upside” of its strategy. Since that time. Yahoo stock has fallen from about $30 to a closing price of $19.18 on Thursday.

Along with a disappointing earnings report, Yahoo announced earlier this week that it will be laying off 1,000 of its 14,000 employees.

“A year has gone by and the competitive situation has not improved,” Ballmer wrote, in a dig at Yahoo management aimed right at disappointed shareholders, who he hopes will pressure the board to take the deal.

Microsoft’s offer is $31 per share, consisting of 50% cash and 50% equity. That’s a 62% premium over Yahoo’s closing price on Thursday.

In a brief response issued Friday, Yahoo said its board is “going to take time to thoroughly evaluate the proposal in the context of Yahoo’s strategic plans. This will include evaluating all of the company’s strategic alternatives -- including maintaining Yahoo as an independent company.” It declined to say how long the process would take.

Beyond its slow growth, Yahoo also has struggled with an exodus of top employees. All of the senior execs but one in the company’s Santa Monica office, for instance, have ankled in the past year.

“A lot more people were going to leave and this deal might help keep them,” said one source close to Yahoo.

Attractiveness to key employees and the ability to compete with Google all will depend on how such a merger is executed, however. Most insiders expect Microsoft would keep the more successful Yahoo as the consumer-facing brand, while integrating the two companies’ research and ad sales operations to gain greater scale.

Just last May, Microsoft bought online ad agency aQuaintive for $6 billion. By combining that with Yahoo’s ad operation, it would be able to offer marketers reach that rivals that of Google.

Microsoft is also hoping that the larger amount of search activity the combo would generate will help improve its algorithms and make it a more attractive alternative to Google for Web surfers, thus bringing in more search-related ad revenue.

Execs said they believe they could find $1 billion in efficiencies from the deal, though they didn’t specify how many layoffs might occur as a result. Microsoft chief financial officer Chris Liddell said he would expect the acquisition to break even or be profitable by the second fiscal year after it closed, which wouldn’t happen until late this year given the likely antitrust scrutiny.

Yahoo stock closed up 50% at $28.38 Friday. The fact that it didn’t go all the way up to Microsoft’s bid indicates that investors still think there’s a chance Yahoo’s board won’t accept the offer. Many observers noted that with the possible exception of a major telco or cable operator, there isn’t another company besides Microsoft with the interest and resources to make such a bid.

If it’s accepted by Yahoo, though, deal will likely face opposition from Google. In a posting on the company’s corporate blog Sunday, Chief Legal Officer David Drummond said a merger would raise “troubling questions.” He pointed to Microsoft’s previous anti-trust problems and questioned whether the combined company would “take advantage of a PC software monopoly to unfairly limit the ability of consumers to freely access competitors' email, IM, and web-based services?”