Yahoosoft!: A Match Made in Heaven or Hell?

Unless you’ve been living under a rock for the past week (which, if you are, you have my sincerest condolences), by now you’ve no doubt heard of the latest drama to hit the technology industry: Microsoft’s attempt at grafting search-engine Yahoo onto its cold steel heart with a whopping $42 billion USD unsolicited bid, which came after Yahoo politely declined a friendly buyout agreement. If my calculations are correct (and, more importantly, if the analysts’ calculations are correct), that’s a 62% premium on Yahoo’s current worth. Now, assuming that good old Steven Ballmer hasn’t been struck with a case of the Tom Cruise crazies, the two top obvious questions are: “What is Microsoft thinking?” and “How does Yahoo feel about the whole deal?”

The cons of the proposed deal are pretty evident. Yahoo has been in a major financial slump which, despite the best efforts of CEO Jerry Yang, doesn’t seem to be improving; hell, the company decided to lay off 1000 people, or seven percent of its workforce, just a few weeks ago, and it seems like the only reason the stock is doing so well these days is precisely because of a likely hostile takeover by Microsoft. $42 billion is an enormous sum to pay out for a company whose economic future is shaky, and whose net revenue is hovering around $6.5 billion a year; at that rate, Microsoft probably won’t start seeing positive cash flow from the deal until 10 years later, a long time span for an industry so volatile.

And remember that huge deal in 2000 between AOL and Time-Warner? Remember how that turned out*? Clearly integrations between two monolithic organizations are a risky venture at best, especially as Time-Warner was bought by AOL just before the dial-up provider started to become increasingly irrelevant, with DSL and other broadband options gaining popularity. Now, I’ve never worked at either company, so I’m moving into the realm of pure speculation, but I’d imagine that the corporate cultures of Yahoo and Microsoft differ immensely, and integrating 13,000 odd people into your organization is going to cause a lot of weeping and gnashing of teeth.

There are decided advantages, however. First and foremost, there’s the issue of the search engine wars, which falls into the broader context of online advertising. Google has a huge advantage in that market, and, as the Internet expands, the profitability of online ads can only grow and grow. Microsoft desperately needs to get its foot in the door, as evidenced by its purchase of aQuantive earlier this year, as well as its Live initiative. Don’t get me wrong, the MS Live suite, which has some pretty useful utilities, can play ball with the biggest hitters in the market including Google and Yahoo, but it simply doesn’t have the recognition that Microsoft needs. No one where I work knows about Live Maps, but mention Google Maps, and everybody begins hopping up and down in an orgy of geek admiration. Buying Yahoo, then, would be a huge advantage in market share and brand recognition, provided of course that MS is able to prevent alienation of Yahoo’s current customers. As Yahoo is one of the largest surviving players from the “dot-bomb” era, a successful deal with MS could mean big things for both companies.

Next comes the issue of content: you can’t sell online ads without popular online content, but you’ll need to suffer some losses in order to create popular content in the first place. By combining both the MSN and Yahoo portal pages into one giant behemoth, MS will be able to collectively harness the revenues from both sites and build upon ad deals for both companies; the purchase might be able to mitigate in some small regard the daunting challenge of combating a Google even more entrenched in the advertising industry than it is right now. Yahoo has loads upon loads of content which MS can draw upon to sell ads.

Finally, don’t think that Yahoo is going to go silently into that good night. If insiders are to be believed, Yahoo is, at the moment, considering bids from NewsCorp, Google, and even Apple, of all companies. Eric Schmidt from Google has personally offered Yang any help he wants in staving off Microsoft’s hostile bid. The issue becomes, then, whether Yahoo is ideologically against the purchase, or whether the potential alliance with several other companies is simply a pragmatic sanction to squeeze more money out of MS. Again, we move into the realm of pure speculation at this point, but, in this case, it probably boils down to a simple matter of cash.

We know that Yahoo has been in talks with Microsoft about a buyout since 2005, even if they’ve shot MS down each year; the two companies are clearly not adverse to negotiations, indicating that an ideological objection cannot be Yahoo’s sole source of opposition. Additionally, if we turn to insiders once more, Yahoo allegedly believes that MS’s offer of $31 a share greatly undervalues the company, supporting the cash hypothesis. With multiple players on the market, Microsoft should start gearing up for a bidding war. Although it undoubtedly has the most cash reserves of any of the companies mentioned, that certainly doesn’t preclude the possibility that Yahoo might just decide to run off with Google.

No matter what Yahoo decides in the end, however, the core rationale behind Microsoft’s attempted purchase of the search engine is a fear of becoming irrelevant in the future of the computing industry, of pulling another AOL. Office and Windows have been traditional cash cows which the company has been able to fall upon to boost up other ventures, such as the Home Entertainment division. However, and MS realizes this, there will eventually come a day when Windows will finally be knocked from the OS throne. It is against this inevitability that the company is protecting itself. If there’s one rule in the stock market, it’s to “diversify, diversify, diversify.” And that’s precisely what Microsoft is trying to do.

Whether it’s a good idea or not remains to be seen.

* Here’s a hint: $99 billion in losses in 2002 alone

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