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Game-Changer for Microsoft

Vishesh Kumar

Give Microsoft(MSFT Quote) CEO Steve Ballmer credit for the scale of his ambition.

On Friday, The New York Post reported that Microsoft had recharged talks to buy Yahoo! (YHOO Quote) for as much as $50 billion. The deal would put a steep premium on Yahoo! shares, which soared more than 18% to $33.38 in midday trading on Friday. Microsoft was off 1.6% to $30.48.

Both parties have refused to comment on a potential deal, the possibility of which has been mulled for quite some time now. But an acquisition of Yahoo! by Microsoft could make more sense than ever, given recent events.

Last month, Microsoft backed down from a bidding war and let Google acquire online ad tech firm DoubleClick for $3.1 billion. And after Yahoo! acquired display ad auctioneer Right Media earlier this week, the markets were rife with speculation about which boutique online ad play Microsoft would logically make next.

But while commentators focused on small players such as ValueClick (VCLK Quote) or Aquantive(AQNT Quote), it seems Microsoft may have been thinking big all along.

And though Microsoft has typically avoided big acquisitions -- skeptics rightly note the complications of a huge deal meshing contrasting cultures -- a buyout would present Microsoft with the boldest of a rapidly dwindling set of options.

Desperate for growth as its core business ages, Microsoft hasn't been able to make inroads into the burgeoning online advertising market. In March, investment bank UBS estimated Microsoft's share of global online ad revenue to be only 7%, compared with 43% for Google and 23% for Yahoo!.

Microsoft also continues to lag behind Google and Yahoo! in search engine market share, with just 10.9% market share in March, as compared with 48.3% for Google and 28.5% for Yahoo!.

That continued flailing is likely silencing those inside the company who believe Microsoft can build -- rather than buy -- its way into nearly any market, given its vast engineering resources.

Meanwhile, Google's acquisition of DoubleClick extends its reach beyond the search ad market, where it has dominated, into display advertising. But more importantly, the company will find ways to sell display and search ads in tandem, enabling buyers to manage their campaigns through one system, as Google CEO Eric Schmidt took pains to point out in a conference call to investors announcing the DoubleClick deal.

The move will allow Google to increase its stranglehold on the online ad market, making it even more difficult for Microsoft to make inroads.

Google is also working to invade several other ad media, ranging from print to video, radio and mobile, simultaneously. The company's goal is to create an operating system for advertising, Schmidt has recently said. And if there's one company that understands how difficult it is to displace a dominant operating system, it's Microsoft. Its own Windows operating system for PCs has allowed it to be the dominant technology player for decades.

A Yahoo! acquisition would give Microsoft additional firepower against Google as it moves to lock in additional advertising media.

Of course, pulling off such a huge deal won't be easy. For one thing, big acquisitions have a history of failing.

But the difficulty of integrating would be further exacerbated by the difference in cultures between the two companies. Known for its disciplined culture, Microsoft is perhaps the most orthodox corporation in a generally freewheeling tech sector. Yahoo!, with a campus drenched in garish yellow and purple, is the only Fortune 500 company with an exclamation point in its name.

Yahoo! founder Jerry Yang reportedly will not use Microsoft products, and concerns about a culture clash forcing a possible exodus of Yahoo! employees after such a deal have reportedly tanked talks about a merger before.

Still, the reality for Yahoo! is that it's increasingly outmatched by Google's growing legions of employees and piling coffers. A deal with Microsoft would put enormous resources behind Yahoo! -- however crudely. And it would immediately give a boost to Microsoft's presence in the Internet ad market.

But if a merger does eventually get done, neither company will acknowledge the most compelling logic for it: Things were looking pretty bleak as they were.