Microsoft mulled Yahoo pact to fight Google

As I’ve been saying for a while now, Yahoo! and Microsoft will find new common ground in the fight against Google (and potentially AOL). Today a new article hit the wires which strengthens my case:

NEW YORK (Reuters) – Microsoft Corp. has held discussions to buy a stake in Internet media company Yahoo Inc. to compete against Google Inc., the Wall Street Journal reported on Wednesday.

Although talks over an equity stake do not appear to be active, Microsoft’s top management remains open to a deal with Yahoo as pressure grows from shareholders to perform better against Google, the newspaper said, citing people familiar with the situation.

Microsoft and Yahoo have discussed possible options over the past year, the newspaper said. Microsoft could sell its MSN online network to Yahoo and take a minority stake in the Internet portal, it said.

Microsoft declined to comment on the report and a representative from Yahoo could not immediately be reached.

Last year, Microsoft had been negotiating to strike a partnership with Time Warner Inc.’s AOL Internet unit, but was shut out when Google agreed to invest in a 5 percent stake in the AOL. Microsoft had been in talks with AOL to use its search technology, which would have given the software giant’s fledgling paid-search business a big boost.

Microsoft’s earnings outlook last week fell well short of Wall Street expectations, as the company signaled more investments for its software services business.

Analysts said Microsoft planned to spend an additional $2 billion in the coming fiscal year starting July 1, speculating that much of that investment would go toward building an ad-supported online service business.

Shares of Microsoft were down 33 cents, or 1.4 percent, at $23.66 on the Nasdaq while Yahoo was up $1.01, or 3.2 percent, at $32.86.

EDIT: Here is the original Wall Stree Journal article :

A Microsoft, Yahoo Tie-Up? By ROBERT A. GUTH and KEVIN J. DELANEY

May 3, 2006; Page C1

One faction within Microsoft Corp. is promoting a bold strategy in the company’s battle with Google Inc: Join forces with Yahoo Inc.

That would be a major departure for Microsoft, the software maker that is legendary for toiling on its own until it captures a new market. However, people familiar with the situation say that Microsoft has considered the idea of acquiring a stake in Yahoo, and that the two companies have discussed possible options over the course of the past year.

Currently, talks of an equity stake in Yahoo don’t appear to be active, given that Microsoft is focusing on a reorganization that it hopes will re-energize its effort to compete with Google, the fast-growing provider of search services and advertising.

Two wild cards remain: Microsoft Chief Executive Steve Ballmer, who has historically shunned large acquisitions, and Yahoo co-founder Jerry Yang, whose support would be key to bringing the necessary Yahoo shareholders on board for a deal. Mr. Yang and others in Yahoo would be hard-pressed to sell to Microsoft, people close to the company say.

However, people familiar with Microsoft say its top management remains open to a deal with Yahoo as pressure grows to perform better against Google.

The increasing pressure on Microsoft — not just from Google, but also from its own shareholders, as well as from advertisers that want an alternative to Google — could help to justify the acquisition or some kind of business collaboration, these people say.

Since 2004, Microsoft has invested heavily to better compete with Google but it has yet to boost its share of search or online advertising. At the same time, Google has released products that some industry experts say could over time eat into Microsoft’s core software businesses.

Microsoft executives say that they are investing for the long haul, and that the online-search market is still nascent and has much room for growth. A Microsoft spokesman declined to comment. A Yahoo spokeswoman declined to comment, saying the company doesn’t discuss “rumors and speculation.”

In one sign that Microsoft may be serious about major acquisitions, it has hired search-industry executive Steve Berkowitz to head MSN, the Internet unit that is building the Web-search business and is leading Microsoft’s charge against Google, including Web search. Mr. Berkowitz, the former chief executive of search site, is viewed as a likely deal maker at MSN, having completed more than 40 acquisitions in his career, according to a person close to the matter. He starts May 8. Mr. Berkowitz couldn’t be reached for comment.

Microsoft’s recent quarterly results provided a picture of the pressure it faces from Google. On Thursday, Microsoft said the MSN unit fell into the red and its revenue declined. Those numbers show it is failing to capture the same online-advertising tail wind that is helping Google. By contrast, Google’s first-quarter net income rose 60% from a year earlier to $592 million. U.S. online advertising generally rose 30% to $12.5 billion last year, according to the Interactive Advertising Bureau trade group and consulting firm PricewaterhouseCoopers.

Microsoft executives also said they will need to boost investments in online businesses in the next fiscal year to levels far higher than Wall Street had expected. That prompted an 11% selloff of Microsoft shares Friday. The stock has ticked lower this week. In 4 p.m. Nasdaq Stock Market composite trading, shares fell 1.2% to $24.01, after hitting a 52-week low during the day of $23.90.

At its core, the clash between Microsoft and Google centers on Microsoft’s attempt to build up its Web-search and online-advertising businesses, and Google’s push to broaden its own offerings onto Microsoft’s traditional turf. Google’s encroachment includes software that lets consumers search the content of their personal computers, and email and calendar services that overlap with Microsoft software offerings. Microsoft has pumped hundreds of millions of dollars into its search-engine technology and an online-ad system called AdCenter, which it plans to officially unveil this week. But so far its approach hasn’t yielded the sought-after results.

In search, “Microsoft appears to be falling farther behind Yahoo and Google,” says Henry Ellenbogen, portfolio manager of the T. Rowe Price Media & Telecommunications fund, whose holdings included Yahoo and Google shares as of March 31. Mr. Ellenbogen considers a Microsoft bid for Yahoo a possibility.

Some investors are growing increasingly impatient with Microsoft’s spending to compete with Google head-on. “Chasing Google in search is a waste of money,” says Walter Price, managing director at RCM Capital Management LLC. Investors such as Mr. Price point to the results so far: Microsoft’s share of the Web-search market dropped to just 10.9% of all U.S. search queries in March 2006 from 14.2% in February 2005, while Google and Yahoo each gained share, according to research firm NetRatings Inc., and in March were at 49% and 22.5%, respectively.

A Microsoft-Yahoo combination could merge complementary strengths. To succeed in Internet-search advertising — the business driving Google’s growth — a competitor needs three core elements: strong technology, a mass of consumers and a universe of different advertisers. Microsoft is spending untold hundreds of millions of dollars on the technology piece, but it doesn’t yet have enough consumers using its MSN service to entice the needed advertisers.

A tie-up with Yahoo could address part of that problem. It has more than 100 million people visiting its site a month, making it the most popular Web site in the U.S. So far it is losing the race to Google when it comes to the technology for matching ads to consumer search queries, though it plans to unveil an upgrade to its system this month.

Combined, MSN and Yahoo would have all three pieces and, at least on paper, could leapfrog Google. Combined, the companies would have the “technology and the scale,” to compete, says Ellen Siminoff, a former Yahoo senior vice president and now chief executive of search marketing company Efficient Frontier Inc.

RCM’s Mr. Price says Microsoft should focus on building its online-ad business around media properties, such as sports highlights that display ads, the type of content services that Yahoo has spent years developing. “To the extent that they can preserve the Yahoo culture and let Yahoo focus on being the next-generation media company — that would be really good for Microsoft,” Mr. Price says.

Short of a wholesale acquisition, Microsoft could sell MSN to Yahoo, taking a minority stake in the Internet portal, say people familiar with the company.

Behind the scenes at Microsoft there are two factions of thinking about a Yahoo deal, say people familiar with Microsoft. One, largely led by MSN veterans, has been focused on Microsoft building its own answer to Google. So far that group has prevailed.

Pushing for more is Hank Vigil, a Microsoft senior vice president who internally is advocating for Microsoft to do a major deal such as a tie-up with Yahoo, say people familiar with Microsoft. Mr. Vigil has a long history of forging (and at times fixing) relations with other companies in the industries in which Microsoft plays. Last year Mr. Vigil led Microsoft in talks to form a joint venture with Time Warner Inc. that would have combined MSN and the media giant’s AOL unit. The plan was scuttled after Google swooped in with $1 billion and took a 5% stake in AOL. Mr. Vigil couldn’t be reached for comment.