Microsoft and Yahoo: Is It Really The End?

After three months of trying to take over Yahoo! by carrot and by stick, Microsoft withdrew its carrot (a 60 percent premium over Yahoo's original stock price) and decided not to use the stick (getting its own directors elected to Yahoo's board). Last Saturday, in a letter apparently dictated through teeth gritted in frustration, Microsoft CEO Steve Ballmer wrote Chief Yahoo Jerry Yang that the assault was over. Now Microsoft is going to try and take on Google on its own.

Or will it? Here's a closer look at the disintegration of the deal and what it means for Microsoft, Yahoo and the Web's other major players.

Microsoft Yahoo's rejection comes at a crucial time for Steve Ballmer and his company: Microsoft's legendary chairman and co-founder Bill Gates will be leaving as a full-time employee in July. A $47.5 billion feint isn't an ideal curtain closer. Ballmer wasn't a lone voice in Redmond urging the merging; the entire Microsoft leadership team (including Gates) was eager to swallow the Yahoo operation. Still, the pressure is now on Ballmer to make sure that Microsoft, which still rakes in billions from its desktop business, maintains its vitality in the Internet-dominated future. In what must have been a tough self-evaluation, Microsoft came to the conclusion that it was necessary to spend almost $50 billion to bolster its Internet forces—an implicit acknowledgement of long-term failure in the online game—and now it's back to square one.

What now? There's still the possibility that Ballmer's move is more of a negotiating tactic than a bailout. After all, Microsoft was successful in getting Yahoo to agree that a sale was possible (the price turned out to be the final hurdle). If Yahoo stock gets stuck, Microsoft might be able to revisit the deal and get an even better price. On the other hand, Yang's refusal might have synced up with a realization on Ballmer's part that there's upside in walking away. Apparently a lot of the people at Microsoft (the ones who would have had to do the heavy lifting in the merger) thought that acquiring Yahoo was a mistake and the company would be better off without attempting a feat of integration beyond anything Microsoft had ever attempted. (Technology mergers have a miserable success rate. But Ballmer has to do something, because the conditions that led Microsoft to this drastic step are as dire as ever. Google isn't going away.

Yahoo Jerry Yang seemed ecstatic in his e-mail to all Yahoos in the wake of his successful defense of the company, gushing about how the exclamation point in the company name will be ascendant once more. (Though in a blog item he more solemnly noted, "No one is celebrating the outcome of these past three months … and no one should.") At every stage of this contest it was clear that for Yang the prospect of losing his company to Microsoft was worse than root canal without anesthetic. That's why he spent, according to Yahoo's recent quarterly results, $14 million on lawyers and advisers to help him fight Microsoft, and that's why he resisted Ballmer's good cop/bad cop routine until the end.

But now he's going to face complaints (and maybe lawsuits) from shareholders who will ask a reasonable question: what's the basis of his insistence that Yahoo is worth $37 a share or more when the actual marketplace (absent a live Microsoft offer) price is in the low 20s? Since the departure of former CEO Terry Semel (whose media focus helped the company in the short run but badly underestimated the Google factor), Yang is deeply involved in revamping the company. But he's not moving fast enough to impress Wall Street. One of the tactics Yang is experimenting with is an arrangement that allows Google to handle some of Yahoo's search advertising, which could be profitable. (Google has figured out how to make more money from search, a fact that doesn't speak well for Panama, Yahoo's expensive new ad system.)

But it's also risky. Primed by Microsoft's prophylactic complaints, government regulators will look hard at the deal, which will increase Google's already dominant grip on search advertising. In addition, notes the somewhat biased critic Steve Ballmer in his letter to Yang this weekend, partnering with Google on this front "seems unwise from a business perspective unless in fact one simply wishes to use this as a vehicle to exit the paid search business in favor of Google." Ouch.

Google The ruling triumvirate at Google—Larry Page, Sergey Brin and Eric Schmidt—knew that no matter what happened with Microsoft and Yahoo, their lead in search was safe. Neither competitor has been able to muster a challenge to Google's ad business, and a merger would have been messy enough to set back both companies. But the Googlers decided that a Yahoo-Microsoft merger could indeed pose a threat, simply because the vast audience it would aggregate would corner the market in mail, messaging and other services. So Google tossed rocks at the proposal in various ways, from charging that the merger would violate antitrust regulations to arranging a test program for the aforementioned Google-Yahoo search ad partnership. If regulators don't kill the program, Google would be more than happy to collect a slice of Yahoo's search revenue.

But though Google is happy that the Microhoo deal didn't happen, there's always that chance that Yahoo, under either Yang or someone else, may one day actually get its act together. Perhaps that could come from a linkup with some new as yet unexpected suitor. Think out of the box here … Amazon? MySpace? eBay? Disney? The Library of Congress? Though those wouldn't help Yahoo's search efforts, a well-managed alliance with any of them would frustrate one or more of Google's ambitious enterprises.

AOL TimeWarner is more than eager to jettison the site, which is a symbol of one of the biggest corporate disasters in history. One tactic Yahoo considered during its defense was taking over AOL in exchange for giving TimeWarner a 20 percent share in the new company. That's a dumb idea for Yahoo—too much overlap—and should be dropped. But if Microsoft wants to bolster its Internet population to make a run at Google in the upcoming cloud computing sweepstakes (where services like storage are hosted not on people's hard drives but services somewhere in the Internet ether), AOL seems an obvious target. AOL is no Yahoo—its assets are lacking in breadth and innovation. But Microsoft could snare AOL for much less than half of what it would have had to pay for Yahoo. And while many of Yahoo's employees would have been ready to run screaming at a Microsoft takeover, AOL-ites would see a Redmond purchase as more of a rescue. Still, Microsoft buying AOL instead of Yahoo would be like a major league team signing Carlos Silva instead of trading for Johan Santana.

Facebook It's sweet for Mark Zuckerberg that all these Internet giants are obsessed with mergers and stopping mergers. That distraction gives Facebook a chance to operate in a less glaring spotlight and, with the help of its new COO, former Googler Sheryl Sandberg, come up with an advertising strategy that will give Google a run for its money.

Users This whole thing was never about real people but the strategic moves of megabusinesses hungry to consolidate power in a dynamic online world. The best thing for the modemed multitudes is to have as many companies as possible trying to come up with novel, innovative, productive and fun services and programs on the Web. Best scenario: Yahoo regains its mojo as an independent, and both it and Microsoft step it up with cool and powerful new services. Worst scenario: the leaders of all those companies spend more time playing the corporate version of Risk than taking risks to develop technology that helps the rest of us.

Join the Discussion