Is Yahoo Worth $44.6 billion?

After what may have been a two-year flirtation, Microsoft is trying again to tie the knot. On Friday morning, CEO Steve Ballmer announced that the company initiated a $44.6 billion takeover bid for Yahoo! It's the second time Microsoft has made a play for the online service. But its current bid is the firm's boldest move yet and is clearly designed to close the gap created by Google, which increasingly dominates the paid search and online advertising business. But in its attempt to catch up, is Microsoft paying too much?

Microsoft's announcement injected some drama into the online ad environment that in recent weeks has left both investors and advertisers worried about the effects a weakening global economy may have on the industry. Still, Microsoft's $31 per share offer amounts to a 62 percent premium over Yahoo's Thursday closing price of $19.18. Never mind that according to recent report by eMarketer, Google's share of the paid search advertising market was 75 percent last year, up from 60 percent from 2006. Yahoo's share in 2007: a meager 9 percent.

For Ballmer, Yahoo clearly seems like a relative bargain considering what he hopes to gain from the deal. "Microsoft and Yahoo should be aligned in some way to create a more effective competitor in the online marketplace," wrote Ballmer in a letter to Yahoo's board of directors. He added that "the market is increasingly dominated by one player who is consolidating its dominance through acquisition. Together, Microsoft and Yahoo can offer a credible alternative for consumers, advertisers and publishers." In response to the offer, Yahoo, which earlier this week reported a 23 percent drop in fourth-quarter profit and announced it would layoff 1,000 employees, said its board "will evaluate this proposal carefully and promptly."

Investors applauded Microsoft's bid, sending shares of Yahoo up nearly 50 percent during early-Friday trading. But the backdrop of the news is an Internet advertising market that has significant potential for growth but still faces some uncertainty. Google this Thursday reported fourth-quarter earnings that failed to meet Wall Street expectations.

Still, Google owns the lion's share of online-ad revenues. Last year, U.S. advertisers spent a total of $20 billion on the Web, a relatively small chunk of the $250 billion ad market overall. Global online advertising is estimated to reach $49.5 billion, a 22 percent increase. "Even though the Internet will likely be more resistant to a downturn than other places, it's far from immune," said David Hallerman, senior analyst at eMarketer.com, which tracks Internet ad spending. "Unless people click on the ad, there's no money. If there is a recession, and consumers pull back, people will be searching less for things to buy."

One potential bright spot in Yahoo's arsenal is a relatively strong display-ad business--those costlier banner or drop-down ads that companies use to heighten consumer awareness of a brand, considered the holy grail of advertising efficacy. "Yahoo is not an insignificant player in display advertising. Neither is Microsoft. We shouldn't bow to Google too early," said Tim Beyers, a senior analyst for Motley Fool. "You have to look at this as an arms race for most properties … to be the dominant provider of advertising in the digital world and advertising, period." Google, however, has been increasingly aggressive in broadening its reach beyond search. Last year it struck a $3 billion deal to acquire DoubleClick, a display- and banner-advertising giant. The Federal Trade Commission has approved the deal, but it will only be finalized if European regulators decide to sign-off in April. Meanwhile, on Friday, the U.S. Department of Justice said it is "interested" in reviewing any potential merger between Microsoft and Yahoo.

Complicating things, of course, is the fact that reliable ways of measuring Web traffic--and, hence, any company's ad revenue potential--is still as much art as science. As for Microsoft's valuation of Yahoo, it's about right for a high roller, some analysts say. "If you're Steve Balmer and want to be the Donald Trump of the Web, you want the most-viewed properties on the Web. Well, Yahoo's got 'em," says Beyers, adding, however, that investors might want to keep their own passion in check and think back to the last tech bubble. "I'm not a bear, but I'm careful when it comes to tech investments right now."