Microsoft-Yahoo's Bigger Problem: Avoiding the Time Warner-AOL Trap

Microsoft's hostile takeover of Yahoo has the potential to be the next decade's equivalent of the Time Warner-AOL merger. It is based on similarly formidable assumptions and issues, such as integrating disparate corporate cultures and monetizing an ad-supported search platform. And there's more.

During the 18-plus months it likely will take the embattled Yahoo and Microsoft to work through their differences, Google's Internet ad dominance and the troubled economy will continue to take their toll on both companies. Google will have had at least a year to make inroads into display advertising utilizing the full breadth of its recent DoubleClick acquisition. Yahoo will likely be forced to sell its 39% stake in Alibaba, a prime piece of Chinese online real estate that the government there wants to keep out of Microsoft's clutches. The protracted recession will have slowed online ad growth--much less Yahoo's overly ambitious three-year plan calling for 25% annual revenue growth.



The time that Yahoo has wasted fending off an inevitable deal with Microsoft at or around the $31 share--with a possible proxy fight in the offing--is Google's gain. In fact, things move so quickly in the digital world, there is evidence that Yahoo already has conceded ground to the competition since Microsoft's Feb. 1 unsolicited bid, which represented a 62% premium to where Yahoo stock was trading. Yahoo's share of domestic search engine traffic and page views have declined in the early months of 2008, although year-over-year unique visitors are up.

Deterioration of the stock market and economy, along with the controversy surrounding the standoff, has deflated the value of Microsoft's bid some 5.3% to $29.36 a share. Yahoo's insistence on a higher takeout price is wishful thinking and faux posturing.

Yahoo's March 18 investor presentation, in which it forecast doubling its growth with no new ideas in a troubled economy, has damaged management's credibility. In fact, Yahoo runs the risk of losing about half of its value as a result of the Chinese government seeking to force the sale of its 39% stake in Alibaba Group, the Chinese Internet firm that owns and other online products. Alibaba has the "right of first offer" in case of change of ownership, according to the 2005 pact with Yahoo. That also would represent a major loss of swiftly rising international business, as well as a unique foothold in the largest, fastest-growing Web market in the world.

Yahoo has placed a $3.2 billion value on its stake in, a business-to-business trading platform that has quadrupled profits on a 60% increase in revenues since it went public with a $1.7 billion offering last year. Yahoo estimates all of its off balance sheet assets in Asia are valued at $12.6 billion.

That may be among the more realistic estimates Yahoo has dished up for investors in the past month trying to make a case for its independence or an improved bid from Microsoft. No analyst has been willing to say Yahoo could achieve more than double the Wall Street consensus of about 11% annual revenue growth the company has forecast. Yahoo's recently released three-year plan calls for doubling operating cash flow from $1.9 billion to $3.7 billion on net revenue of $8.8 billion in 2010, based on 22% growth in global online ads, 24% growth in search and 19% growth in display advertising, in which it still edges out Google. In the end, what matters is the time and market share that Yahoo and Microsoft lose to Google, which cannot be recouped.

However, one of the most underestimated aspects of this ongoing Silicon Valley soap opera is the whether Microsoft can swiftly and cost-effectively integrate and utilize Yahoo to rival Google. Microsoft has never excelled in the development and management of its site. Such consumer services are not comfortably within the software giant's core competencies. The Yahoo acquisition would boost Microsoft's sleeping Online Services division, saving its core Windows and Office systems from being eroded by competing Web software services. Search results for March generally show Google gaining (at 67.25%) over Yahoo (20.29%) and MSN (6.65%)--both of which have declined from the prior year, according to Hitwise statistics released Monday.

If Time Warner-AOL has taught the media world anything, it is that swallowing a big fish in new waters isn't easy. Given Microsoft's heavy-handed arrogance and Yahoo's entrepreneurial free spirit, some on Wall Street are giving the match a 50-50 rate of survival.

It's not so much that cash-rich Microsoft could be about $45 billion in the hole as a result of a failed Yahoo acquisition, as it would be permanently fallen behind Google as the only potential ad-search competitor. Adding together two remote second-place competitors in search advertising does not equal one giant. At best, Microsoft--with Yahoo in tow--could hope to offset Google's search-related volume for targeted online advertising. That said, Microsoft-Yahoo would do well to concentrate on advertising and steer clear of the original and recycled online content trap that has consumed Time Warner-AOL for years.

The ongoing takeover tussle also zaps time and resources away from Microsoft and Yahoo that would be better spent on getting their arms around social networks that will generate $1.6 billion in advertising this year, according to eMarketer, and will generate a growing share of personal information-based e-commerce.

In the meantime, AOL is integrating the UK-based social network Bebo, and Facebook is launching real-time chat to which it will tie targeted ads. That is one of many wakeup calls to Microsoft and Yahoo, if only they would stop bickering long enough to pay heed.

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