Although it is early days in Microsoft’s battle for Yahoo!, the war of words is well-advanced, and much of it is critical of the deal. The New York Times compared the combination’s complexity to “building a spaceship out of spare parts”. Barron’s described it as “the latest example of the triumph of hope over experience”, citing the failed AOL-Time Warner and Daimler-Chrysler mergers. Tech blogger Henry Blodget called the would-be deal a “colossal strategic mistake”, advising Microsoft to exit online advertising altogether. Some questioned the strong valuation in light of Yahoo!’s challenges and anemic 8% revenue growth in 2007. (Offer premium was 62% over Yahoo’s share price on January 31, the day prior to bid announcement. The valuation at announcement was roughly 8x 2008e revenues and 23x 2008e EBITDA.) Though not without risks, buying Yahoo! is the best – perhaps only – way for Microsoft to rapidly achieve scale essential to its success on the web. Microsoft has invested heavily in online services, one of the few market opportunities big and fast-growing enough to offset inevitable decline of its OS/Office franchise. Defensively, failure online poses an existential threat as client-server computing evolves into a web-based, or “in the cloud”, model. The strategic importance of the deal to Microsoft means it will do all it can to win. At this date, reports suggest Microsoft plans a proxy fight as a less expensive alternative to raising its bid materially. However, it is preferable to have Yahoo!’s directors support the bid, making the acquisition friendlier and neater. To that extent, there may be a higher price to which Microsoft would go to avoid a proxy battle even if the latter is cheaper. Regardless, we believe the deal is too important for Microsoft to walk away or be outbid. Adding Yahoo!’s network of web destinations to Microsoft would create the largest global online audience in terms of engagement (22% of total minutes spent online, vs 6% for Google), visitors (52%, vs 35% for Google sites), and page views (9.5%, vs 7.6% for Google) (comScore), plus the biggest subscriber base to web services like e-mail. Combining destination traffic increases targeted advertising opportunities, driving the sale of more ads. Applying behavioral, contextual and demographic analysis to the larger visitor universe yields better click-to-sale conversion rates, raising ad pricing. Better targeting, which improves the ability of advertisers to reach receptive consumers, also opens up the possibility for cost-per-action (CPA) advertising, a potential game-changer in traffic monetization. The combination would create a more powerful hub in almost every area of online activity. In web search, Microsoft ranks third, commanding only 3% of global search traffic, well behind Yahoo (14%) and Google (60%) (comScore). As with branded advertising, combining search traffic would enhance ad revenues. User search experience should also improve as the deal would combine the best of each side’s proprietary search technologies onto one portal. As search, branded and other types of online advertising integrate, Microsoft will be able to offer advertisers more attractive cross-venue alternatives. In web-based e-mail, Yahoo! and Microsoft would own 75% of the market (comScore), with similar dominance in instant messaging. E-mail has strategic value both as a tool and a destination. It is the most popular hosted application – used by both consumers and businesses – and is well-suited for integration with other web services such as photo sharing, mapping and document management. Importantly, e-mail is the common backbone to most social networking sites, which require e-mail addresses from members. With feature enhancements, web mail could become The Meta-networking Site, and perhaps rival search as lead on-ramp to the web. Yahoo is already adding features that mimic or connect to social networks. Yahoo! would also help Microsoft counter the threat posed to its Office software franchise by cheaper, web-hosted (“in the cloud”) alternatives. Google’s Docs suite, though still a drop in the office apps ocean, is rapidly gaining adherents, underscoring the risk: Docs site visits increased from 0.6 million in June to 1.6 million in November 2007, with a 10x traffic lead over Microsoft Office Live (Compete.com). Adding a huge base of consumers familiar with web services would advance Microsoft’s online apps presence, even among business customers given the blurring line between home and office use. Also, Yahoo!’s vast data centers would raise the efficiency and capacity required by Microsoft’s “cloud” initiatives. And Yahoo! brings expertise in online service delivery that is derived from managing very large user communities. Cost savings from a combination should be significant – Microsoft predicts $1 billion of pre-tax savings. Effecting these synergies without damaging the enterprise presents the deal’s greatest challenge; however the savings estimate seems reasonable, perhaps even conservative. Microsoft and Yahoo! each spend billions against each other and Google, much of it in duplicated engineering efforts (e.g. multiple search indexing and ad technologies) and destinations. Overlapping websites include blogging, email, gaming, IM, maps, music, mobile, search and widgets. As the saga of Yahoo!’s future unfolds, the lead protagonists are not standing still. Since announcing its bid, Microsoft has acquired: Danger, a smart phone device and services provider, for an estimated $500 million; Caligari, a 3D mapping software firm; and YaData, an Israeli online advertising targeting company. In this time, Yahoo! announced purchase of Maven Networks, an online video service, for $160 million. It also continues with service innovation and partnerings. The latter includes expansion of its cross-media newspaper advertising consortium, which now covers one-third of all U.S. papers. As for Google, its pending DoubleClick acquisition may close soon, with EU antitrust review perhaps aided by Microsoft-Yahoo!. DoubleClick will advance creation of a single advertiser dashboard; its advertiser/publisher network will strengthen Google’s expansion in branded advertisement. Google also recently rolled-out AdSense for video, building its lead in a big future branded ad medium. Android, Google’s open source, cross-platform mobile operating system, is also gaining ground. Regardless of Microsoft-Yahoo!’s outcome, more web-related acquisitions and partnerships are on the way as players vie for traffic and technology in internet time. Virtually all major web sites and ad networks can be considered up for grabs as Google, Microsoft, Yahoo! and others compete to build bigger ad networks globally. Tools and services that facilitate buy- and sell-side advertising online, e.g. through cross-media integration, workflow streamlining and better targeting, will continue to be in heavy demand. |
