Call it MicroHoo! or Yahoo!Soft, the Bottom Line is Microsoft's Bid For Yahoo Faces Many Obstacles

From Staff Reports

With its $44.6 billion hostile bid for Internet search pioneer Yahoo! Inc. (YHOO), software giant Microsoft Corp. (MSFT) is poised to redefine the deal-making market.

According to an analysis of the deal conducted by the San Jose Mercury News, this is more than just a simple acquisition: The hostile buyout bid confirms Google Inc.'s (GOOG) dominance of the Internet search-and-advertising markets, even as it underscores Google's stranglehold dominance on both of those high-tech venues.

It also stands as the best evidence yet that Microsoft is no longer the feared behemoth that ruled whatever market niche it entered, and that was able to dictate standards throughout the high-tech sector.

Google's lead in the all-important Internet search arena is so commanding that Microsoft and Yahoo can only hope to give it a run by combining forces - even though Yahoo remains the single-most-visited Web site in the world.

After spending millions in a vain attempt to establish itself as the leader in Internet search, Microsoft has abandoned its "go-it-alone" strategy, believing that after forming a dynamic duo with Yahoo, together they can achieve what it wasn't able to do while flying solo.

But this strategy - which an advertising executive somewhat derisively dubbed the "one plus one equals three" approach - may not be a panacea, either, for some real challenges remain. Just getting the deal done could be an unachievable objective. Only time will tell.

For now, here are some of the challenges that a Microsoft-Yahoo linkup faces:

  • Antitrust issues could easily take two years to work out.
  • A corporate culture class between the work forces of Microsoft and Yahoo could mute the merger's benefits - assuming the deal even gets done.
  • Regulatory approvals won't be easy to get, especially since most government bureaucrats still view Microsoft as the powerhouse it once was, and don't see the nuances that have caused its market power to ebb.

And there's one other key point to consider: If any of these obstacles prove problematic - that is, if the Microsoft-Yahoo marriage gets bogged down in negotiations, regulatory approvals, or as an ultra-messy integration - the real beneficiary of this buyout could be Google. As the merger gets drawn out, it could become a major management distraction that allows Google to enhance its already large lead.

Let's consider a few of these issues, as well as the catalyst for the deal, itself.

The Allure of the Deal

During a conference call late last week, Microsoft Chief Executive Officer Steven A. Ballmer said that, "when you combine the strengths of our two companies, the result will be an incredibly efficient and competitive offering for consumers, for advertisers and for publishers."

After first approaching Yahoo concerning a merger about a year ago, Ballmer said he finally called Yahoo CEO and co-founder Jerry Yang last Thursday to tell him Microsoft was launching the bid.

For Microsoft, the attraction is that the two companies compete in three key areas. Presumably, the software giant's leaders believe that by combining these capabilities, a stronger enterprise will result.

Among those businesses, the key one is Internet search: At the beginning of last year, Yahoo controlled 26.9% of this market, and Microsoft 10.4%. Google carried the day with a mammoth 52.6%, according to high-tech researcher comScore. But by December, Yahoo watched its market share slip to 22.4%, while Microsoft skidded to 9.8%. Google gobbled up what those two lost and more besides, picking up six percentage points to control 58.6% of the market. 

So even if the merger goes through, the market's No. 2 and No. 3 companies would merge to create a larger No. 2 that's still only about half the size of Google in terms of Internet search market share.

Yahoo bills itself as being the "most visited site on the Web." By the end of last year, however, Google had leapfrogged both the Microsoft and Time Warner sites to take the second spot behind Yahoo, on which it also markedly closed the gap.

Antitrust Issues

Microsoft predicted - quite confidently - that it would get federal approval for the Yahoo deal this year. The deal also will have to gain the approval of shareholders.

Analysts who follow the industry say that antitrust issues will take two years to work out, especially since Yahoo Mail and Microsoft's Hotmail account for 95% of the Web mail market.

Microsoft can expect a review by the U.S. Department of Justice, the Federal Trade Commission - or both. And the European Commission will definitely scrutinize the deal.

The potential obstacles include:

  • Concerns that the buyout would give Microsoft most of the market for Web-based e-mail and instant messaging, making it the key Internet gatekeeper.
  • Worries about privacy, given the increasingly powerful feature sets that Internet search engines contain.
  • A concern that if Microsoft bundles Yahoo's portal with such services as e-mail that it will be able to regain the market-controlling high ground it possessed a decade ago.

If it takes a year for federal regulators to approve the deal, that approval process could get pushed into the next administration, making it a big wild card. The Bush administration has been fairly lenient in approving big mergers, but there's no guarantee the next administration would feel the same way.
Google, too, could raise antitrust concerns, but most experts say the company will have to tread lightly.

But it may not have to worry: Congress could play that very role. Congress has already announced it would hold antitrust hearings on the Microsoft-Yahoo bid, with House Judiciary Chairman John Conyers Jr., D-Mich., and ranking Republican Lamar Smith, R-Texas, stating in a joint statement Friday that the proposed deal raises "competitive issues," according to a report by Information Week.

In the end, the deal will probably be allowed to go through. Unless the government can prove that someone will offer more, or will do a better job running Yahoo, which is a company in decline, "it's going to be hard to get the government to launch a thousand ships to stop the deal," Gary L. Reback, of Carr & Ferrell in Palo Alto, told the Mercury News.

Culture Clash

Whether Microsoft executives will publicly admit this is a whole different story, but analysts say that the company will face huge challenges in its efforts to meld the two corporate cultures. While both are ostensibly high-tech firms, Yahoo is essentially a Silicon Valley-based media company, while Microsoft is an engineering-focused software firm that operates in the relative isolation of Washington state - far from the influences of Silicon Valley.

As one media report noted, employees at Yahoo work in cubicles - the norm in fast-paced Silicon Valley - while offices are de rigueur at Microsoft.

The track record for successful integrations in the Internet sector is not great, with the badly miscalculated AOL Time Warner [Time Warner Inc. (TWX)] deal serving as a case in point. Exacerbating that concern is the reality that Microsoft has little experience with big acquisitions - and this one is massive, and will take years to make work.

The key issues:

  • What will become of such key branded products as Yahoo, MSN and Windows Live, or the overlapping properties, such as MSN Money and Money and Yahoo Finance, or Yahoo Mail and Hotmail?
  • Will it be possible to combine the different technologies that sit behind and power these key products, since the technology and the products together create the value Microsoft is buying and hopes to extract?
  • Who will lead the combined Web division?
  • And, most of all, will Microsoft be able to minimize or even eliminate the clash between employees and managers who come from two very different corporate cultures?

Microsoft contends it already is working this out. But the company literally took years to integrate Great Plains Software and Navision, even though both had Microsoft-friendly technology and were a fraction of the size of aQuantive - a $6 billion deal that's Microsoft's biggest to date, analysts say. And it's too early to tell how it's done with its buyout of aQuantive last year.

The industry doesn't have a great track record when it comes to integrating new properties. Internet-search-engine-pioneer Netscape virtually disappeared after it was bought by America Online, which, in turn, lost market share and importance after it was bought out by Time Warner. And Yahoo stumbled in its attempt to integrate Overture, an Internet firm it bought in 2003.

One other thing: With a high-tech company, the most-valuable assets of all are able to walk out the door at the end of each day. To really get full value, Microsoft has to persuade Yahoo employees to stick around after the deal closes.

None of these challenges are insurmountable. And Microsoft has billions of dollars in cash to throw at any problem.

Lastly, Microsoft seems to understand that this deal is crucial to its ability to finally reposition itself into a position of importance in the Internet sector.

"It's going to be hard. There are going to be some rough spots. But eventually, it's going to work out," Karsten Weide, an analyst with the market researcher IDC, said in an interview over the weekend

Could Google be the Big Winner?

As this all plays out, Microsoft has to be very careful that the deal doesn't serve to lengthen Google's already-big lead.

For one thing, many analysts are criticizing Microsoft's strategy by alleging that the deal, as proposed, does almost nothing to attack Google's ever-expanding Web dominance.

Indeed, in an ironic twist, it may well be Google - which some analysts have nicknamed "The Mighty Mammoth of Mountain View" - that ends up as the biggest winner from a Microsoft-Yahoo merger.

While the new company - which one industry wag says could be named either Microhoo or YahooSoft - would have more Web traffic than Google, there's a problem. Right now, Yahoo has an edge with display advertisers, so the traffic boost should give the newly combined firm a real boost.

But if it takes two years to get the deal approved, and another two to get the merged entity straightened out, any advantages that the Microsoft-Yahoo alliance brings to the table could well evaporate.

Google has already leapt into the wireless phone market, striking global deals and promoting an open handset standard. The firm is even looking to wager billions to buy U.S. wireless spectrum to launch its own wireless voice-and-data services business.

Competitive Advantages

All is not lost. With its top-rated consumer Web portal, My Yahoo, Yahoo still boasts tens of millions of loyal users. Microsoft's operating systems still run 90% of all desktop computers and a big percentage of the servers that manage the Internet.

If Microsoft could pick the best products, services and technology from each company, and do so quickly and efficiently, it could assemble a powerful PC-and-Internet venture.

But as one columnist noted, at its press conference, Microsoft sounded more like it was talking about the steel industry than anything related to software, the Internet or technology. Microsoft execs emphasized the "economies of scale" offered by the deal, referring to savings on research & development, equipment and labor.

Google, however, is a brand. And, as a company, it is both innovative and relentless. It started out offering a simple search service, and has continued to add products and features that have secured its market position and increased its market power.

At the end of the day, the big question to be answered about the Microsoft-Yahoo deal isn't whether it will happen, or even when it will happen. For it's very likely it will come to pass.

The real question is whether it will work - and whether Microsoft has the ability to make it work.

[Editor's Note: For the latest developments in the Microsoft-Yahoo buyout battle - including Google's potential intervention - in today's issue of Money Morning, please click here].

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