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Yahoo! Deal's Biggest Hurdle: Government

SAN FRANCISCO -- Trying to get Yahoo! (YHOO - Get Report) to agree to a merger may be all that's on Microsoft's (MSFT - Get Report) mind these days.

But just wait until the government steps in.

So far, both the Federal Trade Commission and the Department of Justice are standing on the sidelines as Microsoft doggedly pursues Yahoo! -- and Yahoo! doggedly pursues all other alternatives to Microsoft.

Yahoo! has already rejected Microsoft's cash-and-stock offer of $31-a-share in a deal initially valued at $44.6 billion. But the Internet behemoth has yet to come up with another option, making a merger with Microsoft all the more likely.

Enter the U.S. government.

It's still unclear whether the FTC or the DOJ would preside over an antitrust review of the transaction, assuming it eventually gets to that point. But regardless, there's no guarantee that a marriage between Microsoft and Yahoo! will receive the government's requisite blessing.

Microsoft has already laid the groundwork for its arguments, maintaining that a combination with Yahoo! will allow it to compete more effectively against the industry's top dog, Google (GOOG), which has blown away rivals in Internet search -- and the precious advertising dollars that comes with it.

At the same time, Microsoft and Yahoo! each have greater market share in email and instant messaging than Google, and combining the two companies would widen that lead, making it harder for Google to compete. There's also the simple math of whittling the competitive landscape from three major players to two.

But even if Microsoft and Yahoo! manage to secure approval from the U.S. government, most industry observers agree that it will be much more difficult to convince European regulators to bless the merger.

For one thing, the European Commission tends to frown on any deal that shrinks the total number of competitors, even if it levels the playing field. "The European Union has a much less economic-based standard than the U.S. does," says one antitrust attorney, who asked to remain anonymous because he has clients in the industry. "It is more likely to be concerned by the size of the company."

Also, while regulators in the U.S. tend to be little swayed by complaints from competitors, who have a clear vested interest in protecting their own business, recent public arguments against the deal by Google may be given more weight in Europe.

"The EU looks at the dominance of companies and is receptive to arguments by competitors," the attorney says. "The DOJ and FTC discount arguments by competitors and are more impressed with customers."

Customers that U.S. regulators are concerned with in this case are not necessarily the users who visit sites like MSN, Yahoo! and Google for free, but the advertisers who pay for the eyeballs on the pages.

What's up for debate, at least in the U.S., is whether any of these advertisers would be hurt by a merger between Yahoo! and Microsoft.

Some big advertisers might argue they won't be hurt, and that they would actually prefer to have another large player besides Google, which right now is the only option for anyone who wants to reach a wide Web search audience. Smaller advertisers, on the other hand, who already have a limited reach, might want to keep Yahoo! and Microsoft separate so they have more options.

For the most part, the preliminary antitrust focus has been on search, which Google has single-handedly turned into the most lucrative aspect of the Internet, as well as the area where neither Microsoft nor Yahoo! has been able to monetize -- at least to the extent of their rival.

While Microsoft and Yahoo! have a greater share of email and instant messaging, they have not been able to make much money on them -- nor has Google, for that matter.

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