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Yahoo Deal Will Cut Microsoft's Profit

SAN FRANCISCO - Microsoft's (MSFT - Get Report) bottom line will drop to break-even for about two years if its bid for Yahoo! (YHOO - Get Report) is successful, the company said Monday.

Assuming the deal closes at the end of calendar 2008, Microsoft's earnings per share will be "break-even or better" at least until the second full fiscal year after closing, "depending upon how quickly we can realize synergies, CFO Chris Liddell said Monday at an analysts' meeting in New York City.

That means the company would likely not post a positive EPS at least until late 2010 and probably not until calendar 2011, or during its 2012 fiscal year. Microsoft's fiscal year ends in June.

Microsoft is expected to have EPS of $1.87 for fiscal 2008. The stock ended Monday's session down 26 cents, or 0.9% to $30.19.

Under the proposed deal, Microsoft would pay $44.6 billion to Yahoo! shareholders, half in cash and half in stock. Issuing $22 billion in stock would still be less than the company "put back in 2007" in dividends and buybacks, Liddell said. Microsoft paid out 40 cents per share in dividends in fiscal 2007.

And rather than depleting cash reserves, Microsoft will borrow to reduce its financial risk on the deal. The company is already taking on big technological risks, particularly with the integration, CEO Steve Ballmer said.

Executives reiterated they believe they can find $1 billion in savings from the merger. "Scale is an important gain in terms of capital investment," Ballmer said. Search engine businesses pay out the same fixed costs to index 40 billion documents on the Web, regardless of the number of searches through that database.

And by efficiently combining the two online advertising businesses, "an auction marketplace having greater depth of both buyers and sellers is going to have greater price realization," Ballmer said. With the cooperation of Yahoo management, the companies together could probably find more areas for cost reductions, he added.

Ballmer said he had gotten "push-back from investors" on the company's intention to invest so heavily in its online services business, under which the Yahoo! deal would fall. But he said Microsoft intends to get to 40% share of the market for Internet advertising either with or without its competitor. "We have a chance to get farther sooner through the acquisition of Yahoo!" he said.

Both companies go up against search and advertising giant Google (GOOG - Get Report), which Ballmer estimates has about 75% of the paid-search market.

He said he expects the deal to clear antitrust hurdles. The combination of Microsoft and Yahoo will make the marketplace more competitive by establishing a strong No. 2 competitor, he said, adding, "That will be the message we'll communicate to regulators."

And even the combined businesses would not give Microsoft the dominant share of the market in their shared niches: In the United States, where both companies are strongest, the combination of Microsoft's Hotmail with Yahoo! mail would probably not be more than 20% of consumer email, Ballmer said.

Despite the hit to Microsoft's bottom line, "We still believe we can grow revenue in double digits for fiscal 2009," Liddell said.

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