Microsoft/Yahoo: in the Balance

Google has been unstoppable in its dominance over Internet search engines since its launch in 1998, and as of August 2007 is the most used search engine on the web with a 53.6 percent market share, ahead of Yahoo (19.9 percent) and Live Search (12.9 percent). Microsoft is now on a quest to break Google’s supremacy with the acquisition of Yahoo.

In February, Microsoft went public with a $44.6 billion cash-and-stock bid to acquire Yahoo – just days after Yahoo announced that it was to lay off 1000 workers and saw its fourth-quarter profit fall. Microsoft’s offer amounts to $31 a share, and represents a 63 percent premium over Yahoo’s closing price at the end of January. Google, in comparison, posted fourth-quarter revenues of $4.8 billion (up more than 50 percent) while profits rose by 17 percent. Although Microsoft’s acquisition announcement did not mention Google by name, it indicated that the bid was aimed directly at the rival.

Although Microsoft has been involved in a number talks with Yahoo since 2006 about a potential partnership, this time Microsoft has said that it wants to own the company outright.

David Mitchell, SVP of IT Research at Ovum, believes that the rationale for the acquisition comes from two directions. First is Microsoft’s desire to improve its presence in the search and advertising market. “The addition of Microsoft engineering capability into Yahoo should allow the combined entity to bring new products and services to market more quickly, something that Yahoo has notably struggled with,” says Mitchell.

Second, Mitchell believes, is Microsoft’s desire to protect the solid revenue and margin contributions coming from Microsoft Office. Google Applications do pose a potential long-term threat to Microsoft Office as the functionality becomes richer and more complete. “The online engineering capabilities that Yahoo has will undoubtedly offer Microsoft the potential to bring new services to market, which counteracts the undermining efforts Google is pushing forward,” he believes.

“This merger is anything but clear cut,” adds Dr Hans Friederiszick, Managing Director of ESMT Competition Analysis, who sees the acquisition as a two-pronged issue of competition and privacy. “Competition issues will focus on the question of whether this will encourage unilateral price increases for internet advertising via search engines given the already high level of concentration in this market. This merger will reduce the number of search engine providers with significant global reach from three to two, paving the way for a tight duopoly in these markets.”

The perfect match?

Deborah Allday, Director of the M&A practice at global management consultancy Hay Group, points out that Microsoft and Yahoo are hardly a match made in heaven when it comes to challenging Google. “Much like Yahoo, Microsoft has itself missed key shifts in the market where internet usage is concerned. Two wrongs don’t necessarily make a right,” she says.

Allday believes that Microsoft should concentrate on breaking new ground as internet users’ needs change and evolve rather than competing directly with Google. Allday points to Hay Group research that demonstrates that as many as 91 percent of corporate mergers fail to fully achieve their objectives, as companies struggle to effectively integrate ‘intangible’ assets, such as talent. She believes that as much as 70 percent of Yahoo’s current market value may be tied up in intangible assets.

Indeed, Microsoft’s aggressive bid may not have been a good move for the company – Hay Group’s research has found that 30 percent of executives oppose or undermine mergers, a proportion which may rise to three-quarters or more in a hostile situation. “Microsoft will need to engage Yahoo employees quickly and effectively by communicating an exciting vision for the new company,” recommends Allday. “Protecting the human capital of the new organization by getting Yahoo staff on side from the outset will be a critical challenge, every bit as crucial as the financial due diligence no doubt being undertaken right now.”

Hay Group’s research on mergers and acquisitions reveals that acquiring companies who replace the management team in acquired firms are three times more likely to report significant value created by their acquisition. “Conducting a leadership review as part of due diligence process will help ensure that this process is done in a fair and effective manner – which will ultimately enhance the possibility of achieving a smooth and effective integration of these two technology giants.”

New platforms and opportunities

John Delaney, Principal Analyst at Ovum, believes that the mobile phone could be the key to success for the potential acquisition. “So far, the internet portal players have failed to achieve a convincing level of scale or momentum with their forays onto the small screen. Nor have any of the mobile operators achieved de facto dominance with their portal brands,” he explains. “When it comes to internet services on mobile phones, everything is still to play for in a potential market measured in billions of people. And while the mobile internet opportunity is certainly not the principal rationale behind Mircosoft’s bid for Yahoo, a merger between Microsoft and Yahoo does have some persuasive logic to it when looked at from the perspective of mobile, because the two players’ mobile activities complement each other in some interesting respects.”

There are three key applications for mobile technologies: search, maps and messaging. Delaney believes that one potential route for success is as a mobile internet portal player. By achieving a commanding share of usage for this group of applications, they could be intertwined tightly with the phone’s operating platform so that the applications are easy to use and can be integrated with phone functionality – much like address books and telephony functions of phones at the moment.

Google has already started to target this market. Its search engine works well due to the simplicity of the interface, and the Google Maps and Earth are gaining popularity (although not to the same extent as search). “Messaging is the weakest link of the chain for Google, although its Gmail and Google Talk services are growing” says Delaney. “And now, Google’s Android initiative aims to provide the platform to underpin all these applications, to provide a compelling services environment for mobile users.”

However, a merged Microsoft/Yahoo could provide a hefty counterweight to Google’s mobile strategy. “Microsoft/Yahoo could start to develop the kind of integration between platform and applications that is still only a gleam in Google’s eye,” he says. Yahoo and Microsoft also have a substantial combined user base in the three key areas of mobile internet applications. “Technical work to integrate these communities is already underway, with Microsoft and Yahoo having announced interoperability between their Messenger services in 2006,” says Delaney.

Will they, won’t they?

As of mid-March, Microsoft and Yahoo were reported to be holding informal merger discussions, with both companies declining to comment on the situation at present. Whether the deal will go ahead remains unclear; however, according to Mitchell, one thing is certain. “The market has become used to negotiations being held through proxy posturing in the press, and it is likely that a lot of decisive words will be exchanged through the press while a form of realpolitik carries on behind the scenes.”

Microsoft acquisitions

Not known for massive acquisitions, Microsoft has made some sizable purchases over the years. Here are some of the largest deals:

Source: CNET News.com