Microsoft-Yahoo? Don't Bet On It

Though the combination would be a formidable opponent to Google, company sources say merger reports are based on talks a few months ago

On paper, a merger of Microsoft and Yahoo! looks like the perfect foil to the seemingly unstoppable momentum of Google. Combined, the software giant and the online media titan would have easily the largest audience on the Web, a far more potent advertising engine, and finally, a credible position in the all-important Internet search market.

For those reasons, reports on May 4 that Microsoft (MSFT) and Yahoo (YHOO) are discussing a merger or wide-ranging deal made some sense, especially to the investors who swarmed over Yahoo's shares early in the day. But as was the case with repeated rumors of a Microsoft-Yahoo merger over the past few years, the prospects of a deal look unlikely. It now appears that the reports in the New York Post and The Wall Street Journal were based on talks that happened months ago.

Both Microsoft and Yahoo declined to comment publicly. But a Microsoft source in a position to know about talks told BusinessWeek that there are no current discussions of any significance. Another source close to the situation also indicates that talks are not current.

A Real Alternative

So why all the new excitement about a potential deal? Mainly because a merger or even an extensive partnership would touch off an epic battle for the top position on the Internet. Microsoft and Yahoo together would present the only real alternative to Google in an online world that increasingly resembles the Microsoft-dominated computer software business.

For the past couple of years, Google has romped across the Internet. It has used an increasingly dominant position in search, and the diminutive text ads that appear with search results, to rocket to $10.6 billion in sales last year, up 73% from 2005. And with an estimated quarter of all online advertising already in its pocket, Google has begun experimenting with ads in print, radio, and television.

All that has left many people from media moguls to big advertisers fearful that the company, with a market value of $147 billion, would usurp their businesses and exert outsize control of the rapidly evolving advertising world. Especially with last October's $1.7 billion acquisition of the video-sharing site YouTube and last month's $3.1 billion DoubleClick purchase, advertisers, agencies, and rival Internet outfits have worried that Google would become all powerful online (see, 4/9/07, "Is Google Too Powerful?").

Appealing Ad Alternative

So no small number of players in the industry are rooting for the counterbalance that a Microsoft-Yahoo alliance would create. "It would create a new gorilla in the advertising arena, a super-portal," says Jim Lanzone, CEO of Ask, the search unit of IAC/InterActiveCorp (IACI).

Some Microsoft businesses would benefit from a combination with Yahoo. Neither Microsoft's MSN Web portal, which commands only 10% of online display ad impressions to Yahoo's 48%, nor its AdCenter search ad system, has caught fire. Yahoo's dominance in online display ads, as well as its well-received Panama search advertising system, introduced in February, would give Microsoft's ad efforts a leg up.

For its part, Yahoo has also been struggling to contend with the Google juggernaut. Despite its dominance in display ads, Yahoo now has only 22% of the search market to Google's 54%. And search ads count for nearly all the growth in the online ad business in recent years. The combined entities' search service might attract both more consumers and more advertisers. "Microsoft and Yahoo combined would be a more formidable force against Google," says Ryan Jacob, portfolio manager with Jacob Internet Fund, which counts Yahoo shares as 4.3% of its portfolio.

Fearsome Management Challenge

The biggest prize for the combined companies might be just the thing that sets Google apart: more data on customer intentions. Much of Google's success with search ads stems from its ability to divine customers' buying intentions, so it can show them the most relevant ads and then charge advertisers more for the service. Combining customer data from both Microsoft and Yahoo potentially could close some of the gap with Google.

For all that, the reasons not to do a deal remain stronger than the reasons to do it, according to some observers. For one, combining the companies would be a fearsome management challenge. They're in different states, they have many overlapping services bound to spur turf battles, and Yahoo's Silicon Valley culture retains some enmity toward Microsoft.

Consolidating those operations could take two years or more, by several accounts. "It will cause them to fall behind 18 to 24 months," says Samir Patel, CEO of SearchForce, a search marketing software firm in San Mateo, Calif. "I don't see a compelling reason for Yahoo to do it," adds Charlene Li, an analyst with Forrester Research (FORR). "It would be a nightmare. The memories of Time Warner-AOL (TWX) come to mind."

Slight Savings and Synergy

What's more, the imperative of a deal doesn't appear quite as urgent for Yahoo in particular. Company officials and some others in the company, in fact, have been more optimistic of late, thanks to Panama and some recent wins, such as a deal last month to provide ads for Viacom's (VIA) Web sites and the Apr. 30 purchase of online ad exchange Right Media. "You wouldn't have done that if you were going to sell the company in three or four days," notes Ellen Siminoff, CEO of search marketing firm Efficient Frontier and a former Yahoo executive.

Even for Microsoft, the reasons for a deal look iffy on a closer inspection. To keep Yahoo users, Microsoft wouldn't want to change the branding, but that means savings and synergy could be slight. What's more, there's "almost 100% overlap" in their respective online services, says Charles Di Bona II, senior research analyst at Sanford C. Bernstein, from search services and search ad systems to e-mail and news. "The Googleplex visitor parking lot would be full the day after this deal closes," Di Bona says. "There are all sorts of ways these guys don't fit together."

That said, a less sweeping deal, combining search or advertising efforts, might benefit both companies without unduly burdening them with massive integration issues. "I see partnerships happening more than a merger," says Li.

For what it's worth, Yahoo executives also have indicated they prefer to set their own course. "We're not going to compete with Google by trying to be Google," Jeff Weiner, executive vice-president of Yahoo's Network Div., which comprises its consumer Web properties, told BusinessWeek in mid-April. "We'll compete by being Yahoo." The right price might change those intentions, of course. But for the time being, Yahoo apparently will remain just Yahoo.

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