• by Joe Mandese  @mp_joemandese, February 1, 2008

In a deal that would consolidate the Internet's No. 1 destination, Yahoo, and its fifth largest, MSN, Microsoft this morning made a bid to acquire Yahoo for a record-setting $44.6 billion. The deal, if completed, would mark the largest yet in the ongoing consolidation among the Internet's big bodied players, and would once again reset the playing field for online advertising industry.

Regulatory considerations aside, the deal would seem to be a good "take out" offer to Yahoo's shareholders. At $31 per share, Microsoft's bid represents a 62% premium over Yahoo's current stock value. Based on Thursday's closing price of $19.18 a share, Yahoo's market capitalization was $25.63 billion, according to Yahoo Finance.

"Can't imagine being short and waking up to this --yikes!," one member of Yahoo Finance's message board posted this morning. "Today's price may hit $40 as shorts try to flee a burning building," posted another. "Time to short [Google]! Yahoo will kill them," posted a third.

Microsoft's offer couldn't be timed better from that third perspective, coming hours after Google released disappointing fourth quarter results, among a freefall in the search giant's share value in recent weeks.

If Microsoft's offer is accepted, and passes regulatory hurdles, it would combine highest trafficked Internet destination, Yahoo, with its fifth largest, MSN. Google's sites currently rank second. That would obviously be a boon for a combined Microsoft/Yahoo online display advertising business, building mass at a time when the online ad market appears to be fragmenting at a breath-taking pace.

It also would be a boon for Microsoft's position in the lucrative search advertising marketplace, which is currently dominated by Google. According to comScore's year-end 2007 analysis of the major online search entities, Google dominated the marketplace for U.S. search activity, amassing 5.629 billion queries in December 2007 vs. December 2006, a 30% increase. Yahoo totaled 2.211 billion search queries during the same period, down 4%, while Microsoft had 940 million, up 8%.

While the merger would help close the gap and make a combined MSN/Yahoo a more competitive search player vs. Google, comScore also noted that Google held a 56% share of the more than 113 billion core searches conducted in the U.S. during all of 2007.

The proposal already is winning fans on Wall Street, including influential JPMorgan analyst Imran Khan who advised Yahoo shareholders accept the offer, noting, "Increased advertising scale could drive upside

"One of the biggest challenges facing MSN and potentially Yahoo! is the lack of scale in terms of search traffic compared to Google. 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," he observed. "On a global basis, MSN/Yahoo! could reach approximately 600M unique users and have approximately 28.3% of all searches. Further, we believe the increased scale of the combined search entity would lead to improved monetization due to a number of advertisers, which positively impact coverage, click-through rates, and pricing. Global Standing Should Improve: MSN is the second largest player in Europe behind Google, with broad-based strength spread across a number of countries, while Yahoo! is very strong in Asia, especially in Korea and Taiwan and through joint ventures in China and Japan. A theoretical strategic event between MSN and Yahoo! could create a competitor with strong market share across North America, Europe, and Asia."

But the deal has implications well beyond the current search and display advertising markets. In his offer letter to Yahoo's shareholders, Microsoft CEO Steve Ballmer, emphasized:

"While online advertising growth continues, there are significant benefits of scale in advertising platform economics, in capital costs for search index build-out, and in research and development, making this a time of industry consolidation and convergence. Today, the market is increasingly dominated by one player who is consolidating its dominance through acquisition. Together, Microsoft and Yahoo! can offer a credible alternative for consumers, advertisers, and publishers. Synergies of this combination fall into four areas:

* Scale economics: This combination enables synergies related to scale economics of the advertising platform where today there is only one competitor at scale. This includes synergies across both search and non-search related advertising that will strengthen the value proposition to both advertisers and publishers. Additionally, the combination allows us to consolidate capital spending.

* Expanded R&D capacity: The combined talent of our engineering resources can be focused on R&D priorities such as a single search index and single advertising platform. Together we can unleash new levels of innovation, delivering enhanced user experiences, breakthroughs in search, and new advertising platform capabilities. Many of these breakthroughs are a function of an engineering scale that today neither of our companies has on its own.

* Operational efficiencies: Eliminating redundant infrastructure and duplicative operating costs will improve the financial performance of the combined entity.

* Emerging user experiences: Our combined ability to focus engineering resources that drive innovation in emerging scenarios such as video, mobile services, online commerce, social media, and social platforms is greatly enhanced."