Microsoft Proposes Search Deal With Yahoo

Microsoft has proposed to Yahoo that it ally on a

Microsoft has proposed to Yahoo that it ally on a “transaction” that is something short of the full acquisition that Microsoft abandoned on May 3.

Although the companies aren’t detailing the nature of the May 18 proposal, which remains vague, sources indicate it centers on combinining forces in the search advertising business, an area where both companies trail far behind No 1 Google. Microsoft looks to be interested in buying Yahoo’s search ad business, or at least Yahoo running Microsoft search ads beside Yahoo’s search results, while Yahoo would keep the display-ad business in which it remains the clear leader. Kara Swisher’s hearing the same thing.

(UPDATE: John Furrier and Robert Scoble speculate that Microsoft could pick up both Yahoo’s search business and Facebook and combine them into something to rival Google, thanks to Facebook’s closely guarded and potentially valuable social graph information. I’m not sure Google will be quaking in its boots over this, because Facebook for all its value to users has a long way to go to fulfill its commercial promise, and I’m doubtful it can keep its social graph to itself for long.)

Microsoft’s statement highlights the continuing challenges the company faces in making headway in online advertising against Google. That position was acknowledged Sunday by Microsoft platforms and services chief Kevin Johnson in a memo to employees (full text after the jump). Johnson also said the company will announce a “major new initiative” in search this week at its advance08 ad conference in Redmond, Wash.

The Microsoft statement comes as Yahoo and Google could soon announce their own deal to outsource at least some of Yahoo’s search ad business to Google. To avoid regulatory issues involved with so dominant a force in search as Google essentially taking out a rival, the two companies are believed to be considering an arrangement by which Yahoo would operate an exchange open to all, including Google. It’s possible that Microsoft is simply looking to head off that deal before it’s done.

Microsoft’s announcement also comes after a week in which billionaire financier Carl Icahn launched a proxy fight to replace Yahoo’s board, in hopes of getting a Microsoft-Yahoo deal back on the table. Microsoft has not responded to that implicit invitation. But since Icahn’s move was expected to prompt Yahoo to turn up the heat on a possible Google deal, Microsoft apparently felt compelled to make its own move.

Continuing its recent tradition of waiting until the weekend to make a move, Microsoft said in a statement that it has approached Yahoo with the alternative to the aborted $44.5 billion acquisition that failed to come together after three months of back-and-forth between the two companies. The full statement:

“In light of developments since the withdrawal of the Microsoft proposal to acquire Yahoo! Inc., Microsoft announced that it is continuing to explore and pursue its alternatives to improve and expand its online services and advertising business. Microsoft is considering and has raised with Yahoo! an alternative that would involve a transaction with Yahoo! but not an acquisition of all of Yahoo! Microsoft is not proposing to make a new bid to acquire all of Yahoo! at this time, but reserves the right to reconsider that alternative depending on future developments and discussions that may take place with Yahoo! or discussions with shareholders of Yahoo! or Microsoft or with other third parties.

“There of course can be no assurance that any transaction will result from these discussions.”

For its part, Yahoo issued a response, though it was remarkable chiefly for its lack of a new message:

“Yahoo! has confirmed with Microsoft that it is not interested in pursuing an acquisition of all of Yahoo! at this time. Yahoo! and its Board of Directors continue to consider a number of value maximizing strategic alternatives for Yahoo!, and we remain open to pursuing any transaction which is in the best interest of our stockholders. Yahoo!’s Board of Directors will evaluate each of our alternatives, including any Microsoft proposal, consistent with its fiduciary duties, with a focus on maximizing stockholder value.”

The Microsoft statement, however, is interesting for two reasons: First, Microsoft is so worried about Google gaining absolute control of the lucrative search-ad business that it’s approaching Yahoo anew after trying to persuade the world that it doesn’t need Yahoo after all. Second, it’s now clear that Microsoft has not in fact “moved on” from the possibility of acquiring all of Yahoo, as it has insisted for two weeks, and would consider it under the right circumstances.

A number of people, including I, always wondered why Microsoft felt compelled to spend all that money on an acquisition that Yahoo clearly preferred to avoid. A deal focused only on search wouldn’t solve all of Microsoft’s online-ad problems, but if it kept Google from capturing the No. 2 player in Yahoo, Microsoft at least wouldn’t be in a position of losing any hope whatsoever of a presence in search ads. And Microsoft certainly has the financial means to outbid whatever Google could offer Yahoo, even if Microsoft loses money on the deal for a long time to come, as it apparently has on its Facebook ad deal.

On the other hand, Microsoft’s move, in explicitly leaving open the possibility of a full acquisition, may well lead to that outcome in the end. It’s the result most people, including Yahoo investors, have been expecting all along, even after Microsoft said it pulled out.

Here's Johnson's memo:

From: Kevin Johnson Sent: Sunday, May 18, 2008 1:30 PM To: Platforms & Services Division; APSP FTE - Adv & Pub Solutions Platform; Employees.all.corp.adf@main.corp; Employees.all.adf@main.corp Subject: Online Services Strategy Update

We have been executing against the core strategy I first presented at our Financial Analyst Meeting in July 2007 to go after the growing opportunity in online services and advertising . Four pillars have formed the basis of our strategy: 1. Consolidate ad platform and win in display 2. Innovate and disrupt in search 3. Deliver end-to-end user experiences across PC, phone, and web 4. Reinvent portal and social media experiences We have many options that support acceleration of our strategy. As announced earlier today, we are also considering new alternatives for a transaction with Yahoo! which do not involve a full acquisition. At this time, we have not made a new bid to acquire all of Yahoo!, but we reserve the right to reconsider that alternative depending on future developments and discussions that may take place with Yahoo!, shareholders of Yahoo! or Microsoft, or with other third parties. Regardless of the outcome of any new discussions, it is important that we continue to move forward to strengthen our online services business. The fact is that we are not where we want to be in this business yet and we’ve been in this position longer than we’d all like. To that end, we will be accelerating elements of our core strategy, and breaking ground in new areas. On Tuesday, Brian McAndrews is hosting advance08, our annual advertising conference here in Redmond. Over 400 leaders from across the media, technology and advertising landscape will be here for two days to engage in dialogue on industry trends and opportunities. These leaders are some of our closest partners in the digital transformation of the advertising industry, and they recognize the increasingly important role Microsoft plays in this transformation. We are very excited to have these customers and partners on campus. Brian‘s keynote will highlight our unique position in the advertising industry. It’s amazing to see how far we’ve come with the aQuantive acquisition in differentiating our advertising platform. This foundation is paying off, with Q3 advertising revenue growth of nearly 40%, a rate that has accelerated over the past two quarters while growth rates at Google, Yahoo and AOL have slowed. On Wednesday, we will be announcing a major new initiative that our search teams have been driving. We are getting better and better with our core algorithmic search, and at the same time, we are investing to differentiate in vertical experiences and to disrupt the current model. You’ll hear more about our plans Wednesday. advance08 will underscore our commitment to search and online advertising, and you’ll continue to see announcements demonstrating our progress in this space. Earlier this week, I spoke to leaders across our online services business about our core strategy, the importance of acceleration and a set of actions we are taking, including: 1. Innovate and disrupt in search – We will disclose some elements of our plans with this week’s release of search and sharpen our focus on user experience and business model innovation. The work we have done over the last 4 years on search has established a solid foundation to build upon. 2. Win targeted distribution – With this release of search, we are now ready to throttle up broader distribution initiatives. 3. Reinvent portal and deliver new experiences across PC, phone and web - We are building our new releases of Windows 7, Windows Live wave 3, Windows Mobile 7, Internet Explorer 8, Search and MSN with an eye towards optimizing and unifying experiences and scenarios. 4. Fix our online branding – Our brands are fragmented and confusing today, and we recognize a need to clarify and align our online branding . We are now driving forward to address this opportunity. 5. Win in display advertising - We have an advantage in tools, agency assets/relationships and a team laser-focused on capturing the display ad platform opportunity. As we build from a position of strength, we will increase engineering resources to drive even more innovation. 6. Build on our strengths in Europe – As measured by comScore in March, our online business in Europe is doing well. We have over 3 times the page view volume and nearly 7 times the minutes of usage compared to Yahoo!, and 68% reach to internet users throughout Europe. We will double down on our investments in Europe and expand on this strong position. 7. Expand strategic partnerships – In addition to our organic innovation agenda, we will expand strategic partnerships that increase inventory on our display ad platform, enable new paradigms in search and accelerate growth in key geographies. 8. Pursue small, targeted acquisitions – Looking forward, we will focus on small, targeted acquisitions that support our work in search, complement our value in the ad platform and help us grow scale in key geographies. Recent acquisitions including Rapt and YaData are examples of these types of acquisitions. The PSD leadership team is actively working on the FY09 budget, including resources and investments to support the actions above. Additional elements of our work will be revealed in the coming weeks, leading to our Financial Analyst Meeting in July where I will share more details on our strategy and business/financial outlook. As we move forward, I want to remind everyone that we are well positioned to compete. We have some of the industry’s best assets on our side: technical and business talent, global scale, a culture of self-criticism and tenaciousness, a healthy balance sheet and an unparalleled product portfolio. It’s time for us to seize the opportunity. Thanks again for your continued leadership and focus on our business. If you have any feedback or thoughts, please feel free to send me mail at Regards,

Kevin Johnson l President Microsoft Platforms & Services Division

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