Microsoft-Yahoo Union Would Still Be No. 2

By Mike Musgrove and Cecilia Kang
Washington Post Staff Writers
Saturday, February 2, 2008

A combined Yahoo and Microsoft would still be the underdog in the increasingly important business of Web search if Microsoft's unsolicited $44.6 billion bid to buy Yahoo is approved by regulators and Yahoo shareholders.

In Web search, one of the key services that drive online advertising, Yahoo and Microsoft together have 33 percent of the U.S. search market -- a distant second to Google, which has 58 percent, according to ComScore, a research firm.

Both tried to combat their common rival in recent years by launching efforts to improve their search-engine technology. Both bought dozens of companies to try to bulk up their marketing presence and build their base of advertisers and publishers.

But both nevertheless kept losing ground, employees and advertising growth to Google.

In that sense, an acquisition of Yahoo "buys Microsoft an instant beachhead against Google," said tech forecaster Paul Saffo. But, he said, "it will take some very artful post-acquisition work to make the cultures mesh. That's what really gives me pause, and I'm not sure it can be done."

Yahoo is a Silicon Valley Internet pioneer, known for its whimsical Super Bowl ads and employee foosball competitions. At Yahoo's Sunnyvale, Calif., home, workers chatter between cubicles with gold stars and conference rooms named "chunky monkey."

Microsoft, based in Redmond, Wash., with nearly 80,000 employees, makes much of its money from business software and is known for a traditional corporate regime. Its hallways are typically silent, as protocol dictates that people work behind closed doors.

Many analysts said yesterday that they expected the surprise offer -- a cash-and-stock bid offering a 62 percent premium over Yahoo's closing share price Thursday of $19.18 a share -- to sail through. Some analysts also said an acquisition was an inevitable outcome resulting from some of Yahoo's missteps.

"Yahoo was a pretty innovative company. Five years ago they were leading edge," said tech industry analyst Roger Kay, president of research firm Endpoint Technologies Associates. "But they haven't moved much, and the rest of the world has grown up around them."

Started by two Stanford PhD candidates as a hobby in 1994, Yahoo was one of the first Web companies to grasp the need for a guide to the vast amount of information becoming available on the Internet. The site got more than 1 million hits its first year, at a time when relatively few people were online. The site was first known as Jerry and David's Guide to the World Wide Web.

But after several years of growth -- and an accompanying boom in its stock price -- Yahoo missed a few major online breakthroughs, such as social networking and video, and lost talented workers to rivals.

Microsoft yesterday confirmed that it approached Yahoo about an acquisition several times over the past year but was rebuffed by Yahoo's board of directors. Since October, Yahoo's shares have dropped 31 percent and its had an executive shakeup.

Umesh Ramakrishnan, vice chairman of the executive search firm CT Partners, said Yahoo lost its way under then-chief executive Terry Semel, a former Hollywood executive who hoped to fashion Yahoo into an online media empire. It got into online music, developed its own news sites and hired journalists to travel the world.

"They became more of a large organization and were unable to close the gap with Google," Ramakrishnan said.

Semel stepped down as chief executive last summer and gave up his role as chairman of Yahoo's board Thursday night. This week, Yahoo announced that it would lay off 1,000 employees.

There are "fewer fates less appealing than being a part of Microsoft," said a former Yahoo executive who spoke on the condition of anonymity because of his professional dealings with both companies. Yahoo likes to think of itself as nimble and still able to compete with younger Silicon Valley innovators like YouTube, the former executive said.

If Yahoo is no longer independent, attention could turn to Time Warner's AOL, said Sanford C. Bernstein analyst Jeffrey Lindsay. AOL has been the periodic subject of takeover speculation, and the new Web company landscape might make AOL an attractive acquisition, he said.

"Initially it looks like AOL has been left out in the cold," he said. "But, longer term, it will probably be attractive to both" Google and a combined Microsoft-Yahoo.

Even though Yahoo and Microsoft could end up with a joint workforce of more than 90,000 employees and the corporate backing of one of technology's biggest titans, some analysts say that Google -- which is trying to close its own deal to buy advertising powerhouse DoubleClick -- is poised to become even more powerful.

"This isn't just about grabbing market share. It's about innovation," Saffo said. "Google has been innovating its way into the future. Can Yahoo be more innovative, as part of Microsoft with Microsoft resources? That's the real issue."

Others said the answer appears clear.

"Google is just so far ahead of the curve," said John Aiken, managing director and e-commerce analyst at Majestic Research, an investment research firm in New York. "At the end of the day, you can find what you're looking for on Google faster than anywhere else. And, at the end of the day, that's the only thing that matters."

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