Microsoft's Yahoo Offer Part of A Major Online Play

Microsoft CEO Steve Ballmer's second entreaty to the Yahoo board couldn't have come at a more pertinent inflection point. With the stock market in a downward slide, led in part by Google's dramatic drop after the markets closed on Thursday, Ballmer's open letter on Friday offered to buy Yahoo for almost $45 billion.

Ballmer had previously offered—in a less public way—to buy Yahoo about one year ago. Microsoft was rebuffed at that point as the Yahoo board said a turnaround was underway.

"A year has gone by, and the competitive situation has not improved," Ballmer wrote in his most recent offering.

This offering puts a significant premium on Yahoo's shares. The shares currently trade at just under $20 each, and with Microsoft offering $31 per share, that puts the offer at $44.6 billion, which is close to Yahoo's peak valuation of $48 billion back in 2004.

This time the Yahoo board said it would "carefully and promptly" examine the offer.

Pundits aren't so certain Microsoft's play will help its attempt to become a dominant force online.

"For Microsoft to be a viable Internet only company, the Yahoo deal and other initiatives will have to be executed flawlessly," said Erik Rolf, president of Deliberare, Inc. "Microsoft might be able to make a play for a stronger presence in streaming video and search, but with Google's YouTube and its core search engine so entrenched, Microsoft must execute this acquisition flawlessly and rapidly. I think Microsoft did this because they believed they had to get into the internet quickly, out of fear Google and not because there would be meaningful synergies."

Because the timing was so close to Google's disappointing announcement, let's take a quick look at two reasons why Google missed analysts' expectations:
Lower than expected click-throughs in social networking. There was a lot of hype about Google buying its way into an advertising deal with social networking sites like MySpace. Since Google generates most of its money via advertising click-throughs, analysts expected the growth to maintain at an average 50% but it was 30% in the fourth quarter, a fact Google attributes to a disappointment in trying to get social networkers to click through to ads. Eric Schmidt, Google's CEO, said that the group "is not making as much money as it would like from revenue-sharing deals with social networking websites such as MySpace."
Slowing economy. Ballmer's move does comes at a time when Google appears vulnerable but also at a time when there are significant concerns about online advertising's staying power in an economic downturn. It's uncertain whether rich/streaming media advertising, which Yahoo does well, will have better staying power than Google's typical text-based ads, or whether the economic downturn will adversely affect offline advertising rather than online advertising.

Some analysts attribute the MySpace disappointment to what they call the "chronic unfaithfulness" of social networking users. Online advertising revenues, which make up the bulk of revenue for sites like MySpace and Facebook, are expected to grow from over $40 billion in 2007 to nearly $80 billion by 2010, but it appears that text-only ads are less effective on social networking sites than are rich and streaming media advertisements. If this proves to be the case in 2008, the Yahoo acquisition could prove to have a small but successful gem in its rich media advertising that could propel Microsoft forward in its battle against Google.