Microsoft wants Yahoo

Could a PC software giant and an Internet icon join forces to take on the Web search king?

That was the big question Friday as Microsoft Corp. stunned the online world with a bid to buy Yahoo! Inc. for nearly $45 billion in cash and stock -- a blockbuster proposal that could reshape the industry by combining two tech veterans in a battle against search leader Google.

The deal would be "the next major milestone in Microsoft's companywide transformation to embrace online services," said Microsoft Chief Executive Steve Ballmer in a call with analysts.

However, the unsolicited bid isn't certain to succeed. And even if it does, a combined Microsoft and Yahoo would start out well behind Google in the key measures of search market share and advertising revenue.

Some analysts are skeptical.

"It's a lot of money," said Sid Parakh, an analyst at McAdams Wright Ragen in Seattle. "Yahoo in itself is a dying franchise, and I don't know if buying Yahoo is going to solve the problem that both of them have -- which is more monetization of their traffic versus wanting more traffic."

The companies have discussed the possibility of a combination before, but Microsoft is making the latest attempt as an unsolicited proposal for consideration by Yahoo's shareholders, not as an agreement. According to details released by Microsoft, Yahoo declined last year to enter formal acquisition negotiations with the Redmond company.

Microsoft launched its own Web search engine in 2005 but has struggled to keep up -- posting a $732 million operating loss in its Online Services Business last fiscal year. Yahoo has likewise been struggling, this week announcing plans to lay off hundreds of workers. Its stock sank to a new four-year low after its latest quarterly earnings release.

Microsoft is proposing to pay $31 per Yahoo share, in cash and stock, or $44.6 billion in all. That's a 62 percent premium over Yahoo's closing share price Thursday of $19.18.

In a statement released Friday morning, Yahoo said its board "will evaluate this proposal carefully and promptly in the context of Yahoo!'s strategic plans and pursue the best course of action to maximize long-term value for shareholders."

Microsoft could face competition in its bid. Yahoo didn't close the door on the possibility of weighing offers from other potential acquirers. But analysts said the pool of possible acquirers would be small.

The purchase price would be paid half in equity and half in cash, Microsoft Chief Financial Officer Chris Liddell told analysts. It would reduce Microsoft's cash balance to its lowest point in years. The company, which has been spending large sums to buy back its own shares, reported $21 billion in cash and short-term investments as of Dec. 31.

Microsoft said the fate of the Yahoo brand and other issues would be determined by a joint group of Microsoft and Yahoo executives, should the deal go through. The combined entities would expect to save money through "operational efficiencies," Microsoft said, but it didn't say how many positions it would expect to eliminate at either company.

Yahoo shares closed up 9 percent, at $28.35. Microsoft shares sank more than 6 percent, to close at $30.45.

In a Thursday letter to Yahoo's board of directors, made public Friday morning, Ballmer made it clear that taking on Google is one of the primary goals motivating Microsoft's attempt to acquire the Sunnyvale, Calif.-based Internet company.

"Today, the market is increasingly dominated by one player who is consolidating its dominance through acquisition," Ballmer wrote. "Together, Microsoft and Yahoo! can offer a credible alternative for consumers, advertisers and publishers."

If Yahoo wants to remain independent, "it will need to show investors that it is willing to take radical, value-creating steps," wrote analyst Mark Mahaney of Citigroup in a note to clients Friday morning. Outsourcing the company's search business to Google "strikes us as one of its few options" as an alternative to the Microsoft proposal, he added.

Yahoo recently opened a new office in Bellevue, just down the road from Microsoft, and the facility includes some former Microsoft employees.

"At this building, we are very excited" by the prospect of a deal, said one Seattle-area Yahoo employee, a former Microsoft worker who declined to be identified.

"We have lots of former Microsoft employees. People are pro-Microsoft around here, unlike in Silicon Valley, where they don't know Microsoft. They see Microsoft as from the PC era, and as the big guy up north. So they don't know what to think."

He added: "No one sees Microsoft as a savior. We had a good business plan for this building, but the synergies between the two companies could be interesting."

Microsoft's proposed acquisition faces potential regulatory hurdles in the United States and overseas. Legal experts said the company could face its biggest challenge in Europe, where regulators have been investigating Microsoft. But Microsoft said it anticipates regulatory approval, with the deal slated to close in the second half of the year.

Google dominates the Internet search business, with 58 percent of the market as of November, according to Nielsen Online research. Together, Microsoft and Yahoo would still trail Google significantly, with about a 30 percent combined share of the market.

Microsoft spent large sums to launch its own Web search technology in 2005, after licensing search technology from a Yahoo subsidiary, but despite its efforts, the company has seen little movement in its market share since then.

"One of the biggest challenges facing MSN and potentially Yahoo! is the lack of scale in terms of search traffic compared to Google," wrote analysts with JP Morgan Securities. "We believe that a potential combination between the two companies could solve this issue and close the gap with Google from a search inventory and advertiser perspective."

Terry Semel, Yahoo's chairman and former chief executive, resigned from the company's board Thursday night, the company said in a statement.

In an e-mail to Microsoft employees, obtained by the Seattle P-I, Ballmer gave assurances that the acquisition will "create a company that is in a much better position to compete against an increasingly dominant player in this market," alluding to Google.

One Microsoft employee, who declined to be identified by name, expressed optimism when approached at the company's RedWest campus, a center for its online initiatives.

"I think it's very exciting. Microsoft has a lot of products that complement Yahoo," said the employee, who said he was previously a consultant for Yahoo. "There isn't much overlap. I think culturewise, there isn't a clash. Maybe since Microsoft is Seattle-based, it's more dynamic and laid back. In California, they're more aggressive."

The JP Morgan analysts advised Yahoo investors to accept Microsoft's offer.

A Yahoo deal would be the largest acquisition in Microsoft's history, eclipsing the $6 billion aQuantive acquisition it made last year. Yahoo reported more than 14,000 employees before its recently disclosed layoff plans. The company reported revenue of $6.97 billion and profits of $660 million last year.

What Puget Sound Experts Are Saying

What people are saying about Microsoft's $44.6 billion bid for Yahoo:

"It makes all the sense in the world given Google's dominance. The deal represents a significant premium and Microsoft is one of the few buyers that could swallow such a large transaction. The trick is how you integrate the cultures after the deal is done. In this case the transaction itself might be the easy part. The differences in the companies seem to go right down to the genetics, not just surface level -- and I suspect both sides know it."

-- Kevin Cable, executive vice president at Seattle investment bank Cascadia Capital

"I think it is a brilliant move. As we are seeing consolidation in the online industry, size does matter. And as Google accelerates its growth, it is imperative that others keep pace with them. ...

-- Dan Rosen, chairman of the Alliance of Angels and former general manager of new technologies at Microsoft

"My general reaction was that it was inevitable. Two strong companies, both struggling in a market against a very innovative leader. However, I'm reminded of the saying, 'tying two rocks together won't make them float.' It's not clear to me how two companies that haven't found the formula for success in a market are going to do so together. Particularly since the 'together' will likely contain a far more complex set of decision variables than the two apart. There's clear value in the bulking up of market share, but to be competitive with Google, I expect they'll have to turn to some small companies that have the innovative talent to change the game."

-- Brent Frei, chairman of Smartsheet.com and former chief executive of Onyx Software

"This makes search and online advertising -- and more broadly, the capturing and monetization of consumer attention -- a true two-horse race. The merger would be positive for Seattle in that it will give thousands of tech workers greater exposure to Yahoo's many content sites and social media services -- which in turn will spawn new waves of innovation locally.

"At its core Microsoft is competitive -- this was really the only significant move that they could make to pull alongside Google in search and online advertising."

-- Bill Bryant, who leads the Seattle operation for Silicon Valley venture capital firm Draper Fisher Jurvetson

"The job of integrating two companies and two cultures is huge. They're taking on something bigger than either one of them has done before."

-- Terry Winograd, a professor of computer science at Stanford University

"Once again the incumbent of the last era has cultural problems moving into the next era. ... Google has the best computer infrastructure on the face of the Earth."

-- Former Apple executive turned Silicon Valley venture capitalist Jean-Louis Gassee

The History Of Internet Search

1975: Bill Gates and Paul Allen found Microsoft.

1986: Microsoft makes its initial public offering of stock.

1990: World Wide Web server prototype built.

Archie file transfer protocol semicrawler search engine built.

1991: Gopher is created at University of Minnesota. It grows into a worldwide network of universities and governments.

1993: Aliweb is launched. It still claims to be the Web's oldest still-running search engine.

Excite Inc., another early search engine, is developed.

1994: The University of Washington's Brian Pinkerton launches WebCrawler.

Text of the Encyclopedia Britannica is available online.

Yahoo is founded by Stanford graduate students. The acronym stands for "yet another hierarchical officious oracle."

1995: Metacrawler search-engine technology developed.

AltaVista is launched, "crawls" the World Wide Web.

Microsoft introduces MSN Internet services.

1996: Hotmail is launched.

Yahoo goes public.

1997: Ask Jeeves Inc. is launched.

1998: Google crawler search engine is launched.

Disney buys Infoseek, turns it into Go.com.

1999: Web logs (blogs) invented.

More than 1,000 World Wide Web search engines exist.

2000: Baidu, a leading Chinese search engine, is founded.

AltaVista allows multimedia searching.

Google and Yahoo join to provide search on yahoo.com.

Google indexes more than 1 billion pages, making it the largest index on the Web.

2001: InfoSpace buys WebCrawler.

Wikipedia is launched.

2002: Google's index surpasses 3 billion pages.

2003: Yahoo acquires Overture, which owns AltaVista and AlltheWeb.

Yahoo launches its own search engine, and soon after stops using Google for search.

2004: Google's index surpasses 8 billion pages.

Google launches Gmail, which targets ads to users.

Google goes public.

2005: Microsoft launches MSN Search, powered by its own internally developed search engine. MSN had previously used Yahoo search.

2006: Microsoft retires MSN Search in favor of the Live Search brand.

2008: Microsoft bids nearly $45 billion for Yahoo.

Sources: The companies, Seattle P-I research, Dr. T. Matthew Ciolek of Australian National University, Bloomberg News