All Things Digital

Microsoft taking over Yahoo–that conversation has never come up. [We discussed] search, and Microsoft co-owning some of our search. I will not sell a piece of search. It is like selling your right arm while keeping your left–it does not make any sense.”

–Former Yahoo CEO Terry Semel, The New Yorker, May, 2006

• Read Microsoft’s letter to Yahoo
• View Microsoft’s presentation (PPT)
• Read Microsoft’s conference call transcript
• Listen to Microsoft’s conference call (.wma, 23 min 10 sec)

Google’s relentless success in both search and Internet advertising has finally pushed Microsoft over the edge. The software giant made an unsolicited $44.6 billion cash and stock bid for Yahoo this morning. The offer of $31 a share is a 62% premium over Yahoo’s closing stock price on Thursday.

“Microsoft’s consistent belief has been that the combination of Microsoft and Yahoo clearly represents the best way to deliver maximum value to our respective shareholders, as well as create a more efficient and competitive company that would provide greater value and service to our customers,” Microsoft CEO Steve Ballmer said in a letter to Yahoo’s board of directors. “In late 2006 and early 2007, we jointly explored a broad range of ways in which our two companies might work together. These discussions were based on a vision that the online businesses of Microsoft and Yahoo should be aligned in some way to create a more effective competitor in the online marketplace. We discussed a number of alternatives ranging from commercial partnerships to a merger proposal, which you rejected. While a commercial partnership may have made sense at one time, Microsoft believes that the only alternative now is the combination of Microsoft and Yahoo that we are proposing.”

A compelling proposal and one that Yahoo said it will evaluate “carefully and promptly.”

Though not as promptly as Yahoo’s impatient investors, who proffered their evaluation within moments of market open today. Yahoo shares, which have long been sinking into the mud, spiked nearly 50% in morning trading. And they may soar higher still.

Some analysts believe Microsoft may have to raise its bid to close the deal. “The Yahoo offer could rise above $31 [a share],” Leland Westerfield, an analyst at BMO Capital Markets, wrote in a research note this morning. “The valuation amounts to 12 times projected core EBITDA for Yahoo, net of cash and equity assets from Yahoo Japan and Alibaba and GMarket that amount to ~$12 per Yahoo. The offer, presented as an open letter to [the] Yahoo Board, strikes us an effort to drive a wedge between Yahoo management and directors’ constituencies, who might favor a transaction and those who resist a takeover–and therefore it is our view that Microsoft would ultimately need to sweeten its initial offer price in order to prevail.”

If Microsoft is able to close the deal, it will gain control of an estimated 27% of the search advertising market. That still pales in comparison to the 65% controlled by Google, but it’s an improvement nonetheless. According to a quick analysis by the folks at Silicon Alley Insider, a combined Yahoo-Microsoft would have revenues of $13 billion and operating profits of $1.1 billion in 2009.

As Ballmer said during a conference call this morning, the deal is “the next major milestone in Microsoft’s transformation.”

And, perhaps, Yahoo’s as well. As Kara Swisher writes over at BoomTown, “… while it’s never over until it’s over, let me just say, for Yahoo, it’s over.”

And so a final question, then: Microhoo or Yacrosoft?

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