Microsoft-Yahoo? Don't Bet On It

Though the combination would be a formidable opponent to Google, company sources say merger reports are based on talks a few months ago

by Robert Hof and Jay Greene

On paper, a merger of Microsoft and Yahoo! looks like the perfect foil to the seemingly unstoppable momentum of Google. Combined, the software giant and the online media titan would have easily the largest audience on the Web, a far more potent advertising engine, and finally, a credible position in the all-important Internet search market.

For those reasons, reports on May 4 that Microsoft (MSFT) and Yahoo (YHOO) are discussing a merger or wide-ranging deal made some sense, especially to the investors who swarmed over Yahoo's shares early in the day. But as was the case with repeated rumors of a Microsoft-Yahoo merger over the past few years, the prospects of a deal look unlikely. It now appears that the reports in the New York Post and The Wall Street Journal were based on talks that happened months ago.

Both Microsoft and Yahoo declined to comment publicly. But a Microsoft source in a position to know about talks told BusinessWeek that there are no current discussions of any significance. Another source close to the situation also indicates that talks are not current.

A Real Alternative

So why all the new excitement about a potential deal? Mainly because a merger or even an extensive partnership would touch off an epic battle for the top position on the Internet. Microsoft and Yahoo together would present the only real alternative to Google in an online world that increasingly resembles the Microsoft-dominated computer software business.

For the past couple of years, Google has romped across the Internet. It has used an increasingly dominant position in search, and the diminutive text ads that appear with search results, to rocket to $10.6 billion in sales last year, up 73% from 2005. And with an estimated quarter of all online advertising already in its pocket, Google has begun experimenting with ads in print, radio, and television.

All that has left many people from media moguls to big advertisers fearful that the company, with a market value of $147 billion, would usurp their businesses and exert outsize control of the rapidly evolving advertising world. Especially with last October's $1.7 billion acquisition of the video-sharing site YouTube and last month's $3.1 billion DoubleClick purchase, advertisers, agencies, and rival Internet outfits have worried that Google would become all powerful online (see BusinessWeek.com, 4/9/07, "Is Google Too Powerful?").

Appealing Ad Alternative

So no small number of players in the industry are rooting for the counterbalance that a Microsoft-Yahoo alliance would create. "It would create a new gorilla in the advertising arena, a super-portal," says Jim Lanzone, CEO of Ask, the search unit of IAC/InterActiveCorp (IACI).

Some Microsoft businesses would benefit from a combination with Yahoo. Neither Microsoft's MSN Web portal, which commands only 10% of online display ad impressions to Yahoo's 48%, nor its AdCenter search ad system, has caught fire. Yahoo's dominance in online display ads, as well as its well-received Panama search advertising system, introduced in February, would give Microsoft's ad efforts a leg up.

For its part, Yahoo has also been struggling to contend with the Google juggernaut. Despite its dominance in display ads, Yahoo now has only 22% of the search market to Google's 54%. And search ads count for nearly all the growth in the online ad business in recent years. The combined entities' search service might attract both more consumers and more advertisers. "Microsoft and Yahoo combined would be a more formidable force against Google," says Ryan Jacob, portfolio manager with Jacob Internet Fund, which counts Yahoo shares as 4.3% of its portfolio.