Microsoft proposes to acquire Yahoo!

This was the most attention grabbing news that I heard this year, more than the Fed rate cut, more the the fall in the Indian markets and the rise again. This news is important because this means that Microsoft despite its claims in the market that it doesn't consider Google a threat, is wary of it. On the positive note, MS does seem to be ready to take on this challenge head on and is going to go all out to defeat its competition as it has done in the past. The huge cash coffers that it has, are certainly going to help it fight this battle. However, the interesting thing is that this battle is between two goliaths. Google is smart, nimble, innovate, understands the consumer pulse and has a lot of its own cash too to fight this battle till the end.

Does it makes sense for MS to buy Yahoo!?

I believe that it may make sense for MS to acquire Yahoo!. As listed in the letter addressed to the Board of Directors there are four benefits that MS sees:

1. Scale Economies: Online advertising industry is growing and it is growing faster than print and television. Microsoft has developed a potent tool to monetize the revenue from its online business through adCenter. To get maximum revenue, MS wants more share of online traffic and it seems that has been eluding it. Yahoo on the other hand has lot of hits and repeat online traffic but is not able to monetize it. By this acquisition, MS can make use of Yahoo! traffic and with Zero Marginal Cost start getting more revenue. This is where the scale economies will come into picture.

2. Expanded R&D Capacity: In this knowledge economy, the products are phases out even before the companies realize that the maturity is reached. Therefore, it is important that you keep innovating and provide reasons for the end customers to keep coming back. This requires some of the best minds in the industry to innovate. Yahoo, Google and MS all have a very good pool of R&D professional, PhDs to work on this. By acquiring Yahoo!, though MS can add to this capacity immediately and this additional capacity will be more than the sum of parts because it was earlier working towards innovating against MS.

3. Operational Efficiencies: This is very intuitive because if two websites offer a storage space to store photos, videos, files etc, by combining the two you add capacity and can service more customers with lesser capacity. Even the support staff that is required to monitor servers and keep the infrastructure running with 0 downtime, can be optimised.

4. Emerging User Experience: Both companies would be working on some innovations. By eliminating staff working on similar innovations or by augmenting them, better innovations can be brought to market faster. It will also help combine the two different technologies to come out with something really path breaking.

The reason that is not mentioned in the letter though is, that by combining forces with Yahoo!, MS can focus its energy completely on challenging its sole competitor - Google.  It will be much easier for MS to deal with just Google, than Google and Yahoo!.

Making this compelling offer of $31 per Yahoo! share with a premium of 62% over current Yahoo! stock price of about 19$, MS has made an offer that will be very difficult for Yahoo! to ignore. With annual profits of only $600m, the shareholders have lot of incentive to cash out at this point. Unless Yahoo! has some innovation in its stable that can change the face of the world or which is the next Big Thing, I think Yahoo! will accept this offer. With valuation of $44b dollars, Jerry Yang has definitely something to cheer about. Whether Google will be the next Netscape, that remains to be seen. I am keenly watching, are you?