Microsoft Fires Up Web Wars

The tech sector's 800-pound gorilla, Microsoft(MSFT Quote) has long sought to muscle its way onto the Internet.

And though heavy-handed, the Redmond, Wash., giant's unsolicited bid for Yahoo!(YHOO Quote) on Friday could give its efforts to be a major player in the fast-growing Web sector a big boost.

Cramer: Microsoft and Yahoo! - Woo-Hoo!

In a bid worth $44.6 billion, Microsoft announced a cash-and-stock deal that offered $31 a share for Yahoo! -- a roughly 62% premium to where the stock closed on Thursday.

After the proposal became known, shares of Yahoo! soared more than 48% to $28.47 in afternoon trading, while Microsoft was off $2.15, or 6.6%, to $30.45.

Yahoo!'s board was considering the offer, the company said in a statement. But even if Yahoo! were to accept the deal and the merger cleared regulatory hurdles, it would likely require a lengthy negotiation process, points out Darren Chervitz, director of research at the Jacob Internet Fund, which has a position in Yahoo!.

A combined Microsoft and Yahoo! would create a much more formidable competitor to Google(GOOG Quote). A key advantage of the merger would be the increased scale the new entity would enjoy in its search business -- a combined Microsoft/Yahoo! would have 30% of the search market, compared with Google's 60% -- a point that Microsoft highlighted several times in a conference call for investors Friday morning.

Pooling the engineering teams of both companies would lead to better search technology and would stop Google from gaining further market share in the field, Microsoft said in its conference call.

But in addition to closing gaps where Google leads, the combined companies could also further build on advantages they enjoy over Google.

Both Microsoft and Yahoo! have a number of ways of reaching consumers that Google does not -- and which could potentially steer users towards their Internet platforms, JP Morgan analyst Imran Khan wrote in a research note. JP Morgan makes a market in Yahoo! shares.

Microsoft dominates the desktop and browser markets, is a big player in mobile devices, and makes the popular Xbox Internet-enabled gaming console.

Yahoo!, meanwhile, enjoys strong relationships with DSL providers. "The combination of Yahoo!'s relationships and Microsoft's applications and devices could create a very well-positioned competitor, with access points across many applications and devices," Khan wrote.

A combined Microsoft and Yahoo! would also command more than 10% of total Internet pageviews in the U.S. -- more than five times that of Google -- Khan wrote. The two companies would also be able to pool together their already considerable troves of user data, which would allow superior and more profitable ad targeting.

Blending data could be especially key for a merged entity, since both companies have aimed to take full advantage of the rapidly emerging market of behaviorally-targeted ads, which serves up advertising based on user information like demographics or Web-surfing behavior. These type of ads tend to be more relevant and can command higher rates than generically served ads.

Google has been reluctant to serve behaviorally targeted ads given the privacy concerns they raise and the close scrutiny the company faces on that issue.

According to eMarketer, the market for behaviorally targeted ads is expected to expand rapidly from $1 billion in 2008 to $3.8 billion in 2011.

"We believe scale would make the new entity the leader in behavioral targeting due to the large reach and user data," Khan wrote regarding a combined Microsoft and Yahoo!.

Microsoft Deal Proves Economy's Not Dead

Of course, actually making the acquisition work would be difficult. Large mergers tend to fail as is. And the differences between Microsoft's aggressive, button-down corporate culture and Yahoo!'s more freewheeling Silicon Valley ways have been a frequent point of concerns about a potential deal.