Microsoft and Yahoo: Now what?

by Juan Carlos Peréz

May 5, 2008 —

Microsoft's three-month
courtship of Yahoo has
ended but it changed both companies forever and neither can expect to return
to the way they were.

Microsoft and Yahoo will need to deliver on promises, address questions, reassess
and adjust plans and deal with challenges that grew from and during the attempted
acquisition.

"The key thing is that both companies are going to have to articulate
very clearly what their strategies going forward will be," said Forrester
Research analyst Charlene Li in a phone interview.

Yahoo has the most to prove and deliver upon, while facing a more uncertain
future.

"For Yahoo, this is a situation of 'Be careful what you wish for,'"
said industry analyst Greg Sterling of Sterling Market Intelligence in a phone
interview. "Yahoo's directors and management very strongly indicated that
they wanted to remain independent and now they get that opportunity."

First order of business for Yahoo will be to monitor its stock, which got a
boost after the acquisition bid and now faces a possibly negative reaction from
financial markets.

If the stock gets clobbered in the coming days and doesn't rebound, Yahoo could
find itself an acquisition target again from other suitors, and possibly under
less favorable conditions and terms.

Even if the stock holds up, it's still very likely that Yahoo will be pelted
with a flurry of lawsuits from shareholders that feel the company didn't look
out for their best interests when rejecting Microsoft's offer.

In addition, Yahoo will have to hustle to deliver on all the ambitious plans
and promises it made these past three months, and prove that it can indeed turn
its ship around as an independent company.

Financial analyst Clayton Moran from Stanford Group Company is pessimistic
about Wall Street's reaction to Yahoo and about the company's ability to significantly
improve its financial situation.

"Yahoo has missed an opportunity. We expect the stock to drop materially,"
he said in an e-mail interview.

Moran doesn't believe that in the coming 12 to 18 months Yahoo's stock will
reach the $37 per share value that the company wanted Microsoft to offer and
over which negotiations eventually broke down.

"Yahoo’s best alternative was to sell to Microsoft. As an independent
company, Yahoo has lost market share and struggled to grow cash flow. We suspect
these trends will remain intact for the foreseeable future," Moran said.

Beyond the potential financial turmoil, Yahoo will need to follow through on
the many lofty projects it has kicked off, such as its new AMP advertising management
platform and its Yahoo Open Strategy (YOS) for letting outside developers create
applications across its network of sites and services.

"Yahoo has some very ambitious plans they have announced these past three
months and now they have to deliver and start fulfilling the promise some of
these projects represent," Sterling said.

"The onus is on Yahoo to explain why it's worth $37 per share and in particular
to articulate very quickly what its strategy is, now that it's been given this
reprieve," Li said.

It's also unclear how wise it will be of Yahoo to outsource a significant portion
of its search advertising business to Google, a deal that, if completed, may
be announced as early as next week, according to a source close to Yahoo.

"While Yahoo may pursue a Google search partnership as a way to appease
shareholders through enhanced cash flow, we believe such a deal would face intense
anti-trust scrutiny. In addition, it would cede control of search to Google,"
Moran said.

Li isn't convinced that the deal's short-term financial boost will justify
passing up the long-term advantage of being able to integrate search into its
overall ad strategy. "That's going to be interesting to watch," she
said.

Microsoft also has its own set of challenges created by its bid. For starters,
it needs to explain how it plans to boost its Internet unit now that the bid
collapsed, after outlining many reasons why it needed Yahoo to do it, she said.

This would be a good time for Microsoft to change course and stop vowing to
catch Google in search advertising. "That game is over and Google won,"
Li said.

However, by focusing on unifying display advertising, such as banner ads, with
search advertising in a single platform, Microsoft, as well as Yahoo, could
compete more effectively against Google, whose display advertising business
is very small, she said. The synergy between search and display ads can make
both formats significantly more effective and valuable to advertisers, Li said.

While Google has said that it will make significant progress in display ads
now that it
owns DoubleClick, Li isn't so sure. "Google doesn't have a good feel
for the display ad market, which is an old network of agencies and creative
types and media people who all know each other from ages ago," she said.
"Yahoo and Microsoft really had to earn their way into that space over
the past decade."

Since it obviously has the cash, Microsoft should go shopping for other companies
that could give it some of the products, services and innovative technology
it was hoping to get from Yahoo, said Gartner analyst Allen Weiner. "I'm
looking for Microsoft to get aggressive with a buying spree," he said in
a phone interview.

In an April 25 report, Moran and his colleague Kevin Buttigieg listed some
companies that, if the Yahoo acquisition failed, might make sense for Microsoft
to consider acquiring: Time Warner's AOL,
News Corp.'s Fox
Interactive (which includes MySpace),
ValueClick, CNet
and Facebook.

For his part, Weiner thinks we might see Microsoft pursue an acquisition of
a video platform provider like Brightcove
and ExtendMedia, and an
online presence company to complement its strong webmail and IM services like
Twitter.

But whatever it does, Microsoft should take some concrete steps to move on
in the public eye. "I think Microsoft should do something quickly to show
the world that Yahoo bid wasn't a setback," Weiner said.

IDG News Service