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Originally published February 2, 2008 at 12:00 AM | Page modified February 2, 2008 at 2:36 PM

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Microsoft courts Yahoo to make gains on Google

Microsoft's $44.6 billion bid to buy Yahoo, if successful, could transform the company so significantly that the oft-used descriptor "Redmond...

Seattle Times technology reporter

Microsoft's $44.6 billion bid to buy Yahoo, if successful, could transform the company so significantly that the oft-used descriptor "Redmond software giant" might no longer be adequate.

With what would be the biggest acquisition in technology history, Microsoft is going after chief rival Google by seeking to generate huge sales through advertising, a business with different profit margins and economics than the computer software it rode to riches and dominance.

The purchase, by no means a sure thing, would add millions of users and allow Microsoft to lure advertisers to some of the most popular sites on the Internet. Last year, the company spent $6 billion on Seattle digital advertising pioneer aQuantive for its technology and skill in matching advertisers to audiences on the Internet -- a market expected to be worth $80 billion a year by 2011 and where Google holds sway.

It also raises the specter of layoffs at Microsoft, which has been adding staff almost nonstop for three decades.

Google's Internet search engine is used in three of every five Internet searches performed in the U.S. It's running away with the lucrative business of selling relevant advertising adjacent to search results. It's also investing its profits in businesses that tread closer to Microsoft's long-held and highly profitable turf: software for desktop computers.

"Today, the market is increasingly dominated by one player who is consolidating its dominance through acquisition," Microsoft Chief Executive Steve Ballmer wrote in a letter to Yahoo.

After having private overtures rejected in negotiations over the past two years, Ballmer pitched this latest offer to Yahoo's board of directors Thursday evening and turned up the pressure hours later when Microsoft made public its intentions.

For Microsoft's bid to go forward, it first needs the blessing of Yahoo's board of directors, which was shaken Thursday by the departure of Terry Semel, its chairman since 2001 and the source of Yahoo's earlier rejections. The struggling company said the board will "take time to thoroughly evaluate the proposal," noting that it was "unsolicited" and asserting its option to remain independent.

If the board rejects Microsoft's bid, Ballmer pledged to "take all necessary steps" to complete the deal, which would likely mean taking the offer directly to Yahoo shareholders in a hostile takeover attempt -- a first for Microsoft.

If the board accepts the offer -- a 62 percent premium over Yahoo's share price on Thursday, near its lowest point in four years -- the deal will be scrutinized by antitrust regulators in the United States and Europe. Microsoft executives were confident the deal would pass muster and, if all went smoothly, could close in the second half of this year.

There was no consensus among analysts on the deal.

Investors, however, bid Yahoo shares up to $28.35 each, still shy of the $31 per-share offer. Microsoft's stock fell $2.15 a share, 6.6 percent, to $30.45.

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That decline lowered the total value of the cash-and-stock deal from $44.6 billion to $41.7 billion, a number that will fluctuate with Microsoft's shares until an agreement is reached.

Combining forces

Should the deal go through, executives will have the complicated task of combining the companies in a way that makes sense, and makes money.

Microsoft and Yahoo -- based in Sunnyvale, Calif., and with a new office in Bellevue -- offer substantially similar services and compete directly in at least a dozen categories, including Web e-mail, instant messaging, maps, blogging and the all-important Internet search.

Kevin Johnson, president of the Microsoft division that would likely absorb most of Yahoo, said leaders from both companies would make decisions on technologies, branding and personnel. The company has experience doing this with aQuantive and other recent acquisitions.

The integration would no doubt take time, and some observers suggest that Microsoft may leave large pieces of Yahoo untouched.

"Microsoft is mainly interested in adding Yahoo's traffic to its own and using the Microsoft platform to sell advertisements on Yahoo's sites," Matt Rosoff, analyst with Kirkland-based directions on Microsoft, said in an e-mail. "If they rush to integrate, they could lose traffic, as duplicate sites are eliminated, and advertisers, as traffic drops below the level it was when the two were separate.

"I expect that if the acquisition goes through, we'll see Yahoo run on a fairly independent basis for some time, and with some Yahoo properties never being integrated."

"A game of scale"

Johnson said Microsoft would benefit from using technology both companies have built and bought."The fact is this is a game of scale," Johnson said. "By bringing the companies together we can create a more efficient operation."

He said the companies could eliminate duplicate capital costs, such as servers and data centers. And, instead of having teams of engineers at both companies working on search indexes, for example, some could be freed up to create new kinds of Internet search or work on advertising opportunities in video and mobile devices.

While Microsoft may be conceding that it can't catch Google on its own, it clearly isn't giving up the chase.

"There's plenty of opportunity to drive breakthroughs in search," Johnson said.

Overlapping work force

In addition to overlapping technology, a combined Yahoo and Microsoft would include an overlapping work force, particularly in Microsoft's online services division.

Johnson, asked in an interview if layoffs are planned at either company, said, "We've got to do a great job of getting the right people in the right jobs and making sure that we have the right amount of head count and resources, focused in the right areas."

Employees in Redmond privately expressed concerns about layoffs, which have been rare and typically small in numbers in the past.

Microsoft has about 80,000 employees and is still growing. Yahoo has plans to cut its staff of 14,300 by about 1,000 jobs, or 7 percent, later this month. If the acquisition happened right away, the combined company would have about 93,300 full-time workers.

Mark Anderson, a Friday Harbor-based technology analyst and adviser, said he expected the deepest cuts to be at Yahoo. At Microsoft, layoffs would be "symbolic, but not material, to show they're sharing the pain."

What's more, competition for top engineering talent among Microsoft, Google and Yahoo, as well as a host of startups and smaller companies, continues to be fierce. Microsoft told Yahoo it would "offer significant retention packages to Yahoo engineers, key leaders and employees across all disciplines."

Lots of politics

Cultural differences pose another integration challenge.

Rosoff, the Kirkland analyst, thinks integration will be tricky with "a lot of politics involved."

"There'll be leadership changes," he said. "Some people at Yahoo will probably quit because they don't want to work for Microsoft."

Silicon Valley companies feared and disliked Microsoft as they watched it use its monopoly in desktop operating systems to crush Netscape Navigator in the mid-1990s. That perception has changed in recent years, particularly with the rise of Google, said Tim Bajarin, president of Silicon Valley consulting firm Creative Strategies.

"Believe it or not, as much as the valley loves Google, they have increasingly been concerned with the 'God factor,' " he said. "They are emerging as this behemoth where whatever they say, it happens and it's right."

A combined Yahoo and Microsoft would be a welcome counterweight in some quarters, he said.

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com Seattle Times business reporter Dominic Gates contributed to this report.

Copyright © 2008 The Seattle Times Company

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