Will Microsoft and Yahoo Join to Challenge Google?

By Alan Sipress
Washington Post Staff Writer
Saturday, May 5, 2007

Yahoo stock surged 10 percent and then fell yesterday in the wake of conflicting media reports that Microsoft had renewed discussions with the rival company over a possible merger aimed at countering Google's growing dominance of the online advertising market.

A Microsoft purchase of Yahoo would combine two of the largest online audiences and build a colossus unequaled in the business of display advertising on the Web. But a merger could also prove unwieldy, involving a marriage of companies with divergent cultures and leadership structures, and invite intense government scrutiny over possible antitrust violations, according to analysts.

Discussions between the companies might instead be aimed at Microsoft investing in Yahoo or expanding their cooperation, for instance sharing advertisers or integrating advertising systems, analysts said.

Neither company commented on the reports of new merger talks, which first appeared in the New York Post yesterday and sent Yahoo shares up. Yahoo stock retreated by 1 percent in after-hours trading, after a report in the Wall Street Journal's online edition cited anonymous sources who said Yahoo had ended the merger talks. Microsoft stock closed at $30.56, down 41 cents.

This was not the first time the companies have been linked. Yahoo chief executive Terry S. Semel said last year he had rebuffed an effort by Microsoft to buy a stake in Yahoo's search business. At the time, he dismissed speculation that the two companies had discussed a possible sale. But analysts at both Merrill Lynch and J.P. Morgan suggested two months later that Yahoo was still a tempting takeover target for Microsoft.

Ryan Jacob, a portfolio manager of the Jacob Internet Fund and a Yahoo shareholder, said yesterday that a merger would be a good fit, combining Microsoft's technological strength with Yahoo's leading role in media and Internet consumer services.

"We've always felt the game is Microsoft against Google, not necessarily a three-way race," he said.

As Google has expanded its online business with a series of small- and medium-size acquisitions, Microsoft has found it increasingly difficult to keep pace online, increasing the software giant's possible interest in making a big-ticket purchase, analysts said. Google announced last month it would buy the Internet advertising company DoubleClick for $3.1 billion, outbidding Microsoft.

A Microsoft takeover of Yahoo would represent a dramatic riposte to Google's attempt at significantly expanding its presence in online display advertising, analysts said. While Google now holds a commanding lead in advertising linked to search results, the company has trailed both Microsoft and Yahoo in display advertising revenue. Microsoft and Yahoo also boast a combined unduplicated audience in the United States of 129 million, compared with Google's 108 million, according to Nielsen/NetRatings.

Despite Yahoo's predictions for strong growth later this year, its quarterly earnings announced last month disappointed investors who had hoped the company's new advertising program, Panama, would have performed better, and the stock price tumbled. Yahoo's stock rebounded yesterday, closing up $2.80 at $30.98.

"If they sell out, it would be an acknowledgment they can't compete as an independent entity," Scott Devitt, an analyst with Stifel Nicolaus, said.

For Microsoft, a merger would help the company establish a major online beachhead at a time when the company's core software business is threatened by the Internet, said Charlene Li, an analyst with Forrester Research.

She said in an interview that Microsoft and Yahoo executives have likely been talking to each other all along but that Google's purchase of DoubleClick heightened the urgency of these merger discussions. "On paper, the deal makes sense," Li wrote in her blog. "But in the end, it's going to be so hard that I don't think it will happen."

Staff writer Tomoeh Murakami Tse in New York and staff researcher Richard Drezen contributed to this report.

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