Microsoft's Big Online Ad Buy

In its largest acquisition ever, the software giant is spending $6 billion for online marketing powerhouse aQuantive

There's rarely been a doubt that Microsoft (MSFT) intends to compete with Google (GOOG). Yet for the past few years, the software giant's efforts to take on the search giant appeared to be half-measures, as its focus always seemed diverted by other businesses. But on May 18, Microsoft made its boldest statement yet that it intends to become a dominant force in the online world. The company dug deep into its vast cash holdings and agreed to its biggest acquisition ever, a $6 billion purchase of online marketing powerhouse aQuantive (AQNT).

The deal, which the company expects to close in the second half of 2007, gives Microsoft a potent online marketing base for selling ads, placing them, and giving advertisers tools to measure ad performance. It turns Microsoft—already a force in online content with such sites as MSN—into a formidable Web power with many of the marketing pieces that advertisers look for as they embark on Internet ad campaigns.

And while Microsoft has spent lavishly in recent years to build up its online business, buying aQuantive is the clearest sign yet that Microsoft intends to create a business rivaling its PC and server software empires. "It's a big bet on advertising monetization for the long-term growth of the company," Kevin Johnson, president of Microsoft's Platforms & Services Div., said during a conference call with analysts and reporters.

Last One Standing

What's more, the deal may muzzle critics who lampooned Microsoft for failing to match Google's ambitions for Web dominance. "They've exited the 'day-late-dollar-short' club," says Sanford C. Bernstein analyst Charles Di Bona II. The deal comes just a month after Google bought Web ad giant DoubleClick for $3.1 billion, reportedly outbidding Microsoft.

There's no question that Microsoft paid dearly for aQuantive. That's because it was one of the last major online ad firms standing, after the recent sales of DoubleClick, RightMedia, 24/7 Real Media (TFSM), and Digitas (PUB) (see 5/21/07, "Behind Those Web Mergers").

Microsoft says it beat out competitors, offering $66.50 a share in cash, an astonishing 85% premium over aQuantive's May 17 closing price. While Microsoft's shares inched down, dropping 15 cents, to $30.83, most analysts seemed willing to accept the premium it's paying for aQuantive as the price of competing with Google. "It was clear that if they didn't get this one, there wasn't going to be anything left on the table," Bernstein's Di Bona says.

Stepping Up the Deal Pace

It's also the kind of acquisition that few companies besides Microsoft could pull off. With $28.2 billion in cash as of Mar. 31, Microsoft clearly has the financial wherewithal. "This acquisition continues to demonstrate that we are willing to use the strength of our balance sheet … to aggressively accelerate our growth and support our strategic initiatives," Chief Financial Officer Chris Liddell said during the conference call.

Microsoft's acquisition pace, particularly for online businesses, has picked up in recent months (see 5/4/07, "Microsoft's Urge to Merge"). But this deal surpasses any other purchase Microsoft has made by a factor of four. The company bought the Danish small-business software maker Navision for $1.45 billion in 2002. Recently, Microsoft has made morsel-sized purchases of ad businesses, including video-game advertising firm Massive, and mobile-phone advertising companies ScreenTonic and MotionBridge.

Microsoft CEO Steven Ballmer was kept apprised of the negotiations but never got personally involved, according to Yusuf Mehdi, senior vice-president and chief advertising strategist at Microsoft, who closed the deal with Johnson and others. While Ballmer was engaged in Microsoft's strategizing over the deal, his involvement in the talks was largely limited to a conversation with aQuantive CEO Brian McAndrews to "express his enthusiasm," Mehdi says.

Online Ads' Coming of Age

In aQuantive, Microsoft gets a company that generated $442.2 million in sales last year, registering 43% growth. Profit grew 53%, to $54 million. Its business comprises three key brands: Atlas, which provides tools for advertisers to generate better returns on ad campaigns; DRIVEpm, a service to match ads with Web-page inventory; and Avenue A|Razorfish, one of the largest online ad agencies in the world.

The business is a far cry from Microsoft's software monopolies, particularly the ad agency business, which is about as culturally removed from software development as it gets. Some analysts question whether Microsoft will spin out pieces of Seattle-based aQuantive, but the company says it intends to keep the company intact. And with Microsoft's deep pockets and grand ambitions, McAndrews believes that aQuantive will achieve far more than it could have on its own. He says it's akin to "trading gasoline fuel with rocket fuel."

More broadly, the deal caps a spate of mergers signaling a coming of age in online advertising. "We are finally at the cusp of where traditional advertising budgets are giving way to online budgets," says Forrester Research (FORR) analyst Shar VanBoskirk. And while online advertising is a mere 10% of total ad spending, this deal and the recent raft of similar transactions suggests that the industry has turned a corner. Valuations have climbed because it's evident that companies that don't build up their online marketing prowess now will be left far behind. With the aQuantive deal, Microsoft has made sure that it's along for the ride.

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