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Tuesday, September 26, 2006

Will Microsoft Buy Yahoo! At A Discount?

One of Microsoft's major problems is that MSN still lags behind Yahoo! and Google in search. ComScore puts Google's share at just below 44% with Yahoo! just below 29% and MSN at just below 13%. And, MSN has been losing share. Combined Yahoo! and MSN would have a share about equal to Google's.

Google still trails Yahoo! and Microsoft in terms of total monthly page views, so the battle is not entirely over, but Google's tremendous revenue growth is based on its power to deliver a huge audience of targeted and relevant search results. Based on the current share of that market, it would seem improbable that Yahoo! or Microsoft will catch Google, even it they improve their search technology.

Microsoft has launched its new digital advertising solutions initiative and Yahoo! plans to upgrade its core search technology, but that project has been running late.

Microsoft has a number of reasons to want to see Google knocked down a notch. Google's distribtion of everything from free spreadsheets to free small business services threates to undermine part of the core revenue base at Microsoft. The launch of Microsoft Live Search is almost certainly aimed at blunting Google's progress.

But, for Microsoft, all of this may be too little to late. And, Yahoo! seems to fare worse in the internet search and advertising market as each day passes.

There have been rumors for some time that to solve their mutual problems, Microsoft might buy Yahoo!. Whatever cultural issues existed that might block the move, valuation was always a problem. But, Yahoo! is down from a little under $44 earlier this year to under $25 now. And, oddly enough, at $27.20, Microsoft is nearing its best price since late 2004.

Yahoo!'s market capitalization has fallen to $34.5 billion. The company has about $2.5 billion in cash and short-term securities and $750 million in debt. That brings the cost to acquire the company as low as $33 billion. Yahoo!'s twelve-month trailing revenue is almost $6 billion and cash flow from operating activities is approximately $1.7 billion. So, Microsoft would have to pay a little over five times revenues and twenty times cash flow.

Expensive. Maybe.

It depends on what value Wall St. would give to such a potentially huge strategic advantage in its war with Google, not to mention Yahoo!'s already profitable and still growing business.

Microsoft's market cap is now up to $271 billion. Cash and short-term investments are over $33 billion. Cash flow from operating activities is over $14 billion a year.

In short, with all the complaints about what MSFT will do with its cash, it could come close to buying Yahoo! without talking to a banker.

For a number of years, Microsoft has suffered from the perception that it cannot do anything beyond making operating system and server software. They have been good businesses, great businesses, but the company's move into the internet portable business, game platforms, and software for mobile devices has not drawn much applause from the investment community.

With the Xbox platform receiving a more favorable impression from the market, Microsoft is beginning to trade like a company that investors believe has some market upside. Taking the lead in internet audience and pulling equal with Google in search could cement that.

Douglas A. McIntyre can be reached at He does not own securities in companies that he writes about.

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