Microsoft (MSFT) offered to acquire Yahoo (YHOO) this morning and--if the $44.6 billion offer is ultimately accepted by Yahoo’s board--this will be the largest technology sector acquisition in history. Over the past few years, Yahoo’s stock performance has been uninspiring in the face of stiff competition from the web search, advertising, and online application industry leader Google (GOOG). A few statistics will illustrate Google’s web dominance; Google claims 56% of web queries which is almost double the combine share of the second and third most popular search engines, namely Yahoo and Microsoft. Search engine usage is essential to drive advertising revenue, as Neilson Online reports that searches account for 37% of the rapidly growing online ad market, some analysts expect that online advertising market could double by 2010. Furthermore, for the last 8 quarters Yahoo’s profit has declined each quarter with a 4th quarter 2007 decline of 24%; in contrast, Google has enjoyed substantial profit increases for the last 14 quarters.
It is quite apparent that Yahoo is not able to compete with Google, which seems to make all the right moves and one step faster than anyone else. Yahoo is trailing in their most important markets: web searches and ad revenue. Microsoft is also in need of some retooling because Google has begun to take a bite out of their market share for word processing, spreadsheet and other applications that Google offers for free to anyone with an internet connection. Microsoft Office is one of the cornerstones of their business model, but Google is constantly improving their free version with nearly the same functionality. Furthermore, Microsoft cannot afford any more slip-ups after the somewhat disappointing release of Vista last year.
It is probably a wise decision for Microsoft to combine its efforts with Yahoo in order to compete against Google. Microsoft’s offer to pay a 62% premium over last night’s closing price for YHOO shareholders represents an immediate windfall for a struggling stock that will be hard to turn down. The companies investigated merging in 2006 but abandon the effort in early 2007 and Yahoo CEO Jerry Yang has been known as antagonistic toward Microsoft for years. A representative of Microsoft claims that the companies would save $1 billion in annual synergies resulting from eliminating overlapping efforts in Research and Development costs to expand online ad sales.
In the opinion of Ockham Research, the two companies will need to find many such “synergies” in order to compete with Google. We expect this merger to be an organizational nightmare, which will require serious restructuring and job cuts. Also, both corporations have entrenched cultures which will likely prove difficult, if not impossible, to merge. For example, can you imagine the Microsoft Word product team relinquishing power to a Yahoo Documents team in order to make their services more web friendly and thus more competitive with the ever innovative Google Docs? Even if the Microsoft and Yahoo teams successfully implement their union, will their combined bureaucracy allow them to innovate faster than Google? Note that the combined headcount for both Microsoft and Yahoo approaches 90,000 compared with Google’s nearly 17,000. It is our belief that this merger is worth a shot, but can be seen as recognition of both companies’ past failings to structure their business lines in order to compete in an increasingly web-dominated market.
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