Q&A With Microsoft On Proposed Yahoo Purchase: 2+2 = #1

Microsoft Yahoo

Greg Sterling and I have just finished a short Q&A with Microsoft’s Yusuf Mehdi, senior vice president of strategic partnerships, about his company’s bid to acquire Yahoo. How does Microsoft plan to integrate Yahoo, if its proposal wins? The plan right now is one more about how the two companies will coordinate to figure out those details, rather than one already outlining which products will survive. But without a specific plan like that, how does Microsoft justify the huge sum it wants to spend? Two plus two equals one, is the answer – Microsoft thinks both it and Yahoo are number two players to Google’s number one and that combined, they can rival the Big G. Our Q&A is below.

In this Q&A, note that the questions are paraphrased on what we asked. Our focus was on recording the responses, rather than the exact questions. But they’re pretty true to what we asked. I’m listed as the author since our system can only list one author on a post. But Greg Sterling is co-author with me and in particular wrote up history on other mergers at the end of the piece.

Question: Tell us about the integration. The conference call didn’t go into specific details about which products would survive or how the companies would be brought together exactly. In fact, it even said some of this couldn’t be decided until Yahoo was involved.

Answer: "We know the approach we want to go about in getting answers to these questions," Mehdi said. In particular, he explained that the "plan" is largely one about how two large companies with similar assets decide to merge, once a deal to combine is underway. Mehdi used the HP-Compaq merger as an example.

"They set up a clean room, brought senior executives in from both companies and were allowed to look at each others’ data. They couldn’t return to their companies if the merger didn’t go through. By being in there, they were able to go through strategies while it [the deal] was going through the regulatory [approval] process. Coming out of that, they were able to hit the ground running. It’s going to take some time to get through the regulatory process. We’ll take all of that time to bring in people from Yahoo and think about all the big meaty questions, how the brands come together, the software architecture, what works better and make decisions that way," he explained.

Continuing on, he addressed some of the issues specific to search and ad delivery.

"We do know the synergies are getting to one index and one algorithmic approach. It does not make sense to have millions of dollars of servers and capital expenditure to do the same thing [index web pages and other content and make it searchable]. We can take all the engineers that were doing duplicative work and apply them to other areas. That’s one thing we know.

On the advertising side, it’s a more nuanced question. Some pieces are purely complimentary, like Avenue A/Razorfish. Right Media is a strong ad exchange. We’ll figure out how to bring together other things like Blue Lithium. And on the paid search and ad platform, exactly how do we do that? Processwise, we need to take some time and look at that."

Question: There have been talks in the past, but how did today’s move finally happen?

Answer: "We’ve been in dialog with Yahoo for some time …. we basically got to the point and decided that time is now to get together and be a credible challenge to the one dominant player [Google] … we thought we could make a very compelling offer. As we thought about the offer, we wanted to present that to the shareholders as well as the board, so they could hear from us first. We wanted to get that out there and thought it was the right thing to do, to be very transparent. Steve Ballmer spoke with Jerry [Yang] about it.

Question: What did Jerry say?

Answer: I won’t get into what was said. He [Yang] wants to be thoughtful about it.

Observation From Us: That Steve Ballmer called Jerry Yang was mentioned on the conference call as well. The mention seems to be designed to generate a feeling of some close relationship or courtesy with Yahoo for the analysts, press, and others listening.

Perhaps. But it feels more like that Microsoft decided to make a move on Yahoo and gave the company a last-minute heads-up that it was launching a takeover attempt. The fact that Yahoo put out a press release headlined Yahoo! Board of Directors to Evaluate Unsolicited Proposal From Microsoft certainly doesn’t suggest that Yahoo’s particularly happy or chummy about the move.

Question: We know there have been talks, but between the two companies, they seemed to have stalled early last year. Now this happens. When got things moving again?

Answer: "Certainly in the last month or so, I’d say in earnest, we [Microsoft] came back around in looking at a combination and went through our thought process to get to where we are."

Question: Yahoo’s stock price has risen sharply since the news came out (at the time of the call, it had risen from about $19 per share to $29). Doesn’t that cut in to the attractiveness of your offer, which was high compared to the lower value?

Answer: "It’s a very compelling offer for the shareholders of Yahoo. Our view is the value of the company has always been independent of the stock price. We can’t quite predict stock movements of our own. Likewise here, we understand the native value of it [Yahoo].

Observation From Us: In short, Microsoft is saying Yahoo is worth $45 billion, regardless of what the stock price is. Currently, with the stock’s rise, Yahoo is valued at around $37 billion, according to the market.

Question: To come back to integration, surely some group at Microsoft has been pondering what products survive or how things get merged. Are there not any more details on this?

Answer: "We have not made decisions at that level, such as what to do with maps or mobile products. Every alternative is on the table. We will evaluate all those options and decide. We’ll pick whatever we think is the best option"

Question: What are you pondering in terms of the employees, layoffs, or avoiding culture clash and protecting morale?

Answer: "We have in the plan lots of stabilization and retention of employees, in particular the engineers, number one. Number two, they are a very competitive bunch and have a lot of pride …. For people who want to work for large scale projects, we think we’ll be a challenging place to work."

Question: It just seems amazing that you’re going to spend $45 billion without someone having worked out how this all comes together. How do you justify that?

Answer: "The synergies are really in four areas …. on revenue and cost, search and ad platforms in particular. The real cost is in the servers and indexing. You can combine that to one. That is a big thing. Whether we use their front end or our front end, it doesn’t really matter. What matters is getting to that single backend. It also gives us an expanded R&D capability. This really does help us enhance and get a critical mass of where we are at a disadvantage [now]."

Question: If the saving is in the indexing, why couldn’t you consolidate by fighting back against Google by proposing an open index that you, Yahoo, and anyone else would use [see Google: As Open As It Wants To Be (i.e., When It's Convenient) for more about this idea]? And if getting more engineers helps for R&D, why not save by just stealing them away by paying a lot more? Can you express what are the key features that make getting Yahoo worth so much money? In particular on the call, no one talked about the traffic they have — that they are a strong number two, and by getting them, Microsoft moves up from number three. Isn’t that part of the value?

Answer: "The main point is by combining the two, the best of both, we can get the scale, a search effort, a platform effort and an audience effort to get what we want to occur, to create a credible alternative [to Google]. Right now, we have two number twos out there in the marketplace, neither of which is at scale, which makes consumers think ‘I’ll use the other guy’ …. That we definitely know. That’s what drove the proposal to make this combination."

Observation From Us: Bottom line, Microsoft does have a convincing case that by gaining Yahoo, it can build up a bigger presence for itself in the search and online ad spaces. On a long-term basis, spending such a huge amount to gain Yahoo and not be left out may well be worth it.

But it isn’t necessarily clear to us that both have to combine for someone to be "credible" against Google. Yahoo, in particular, has stayed a strong alternative in some areas  to Google [with respect to Microsoft, there are not two number twos. Yahoo's number two, and Microsoft is still playing catch-up from number three].

Combined, potentially Yahoo and Microsoft are stronger competitors to Google across a wider range of areas (especially as Google’s ambitions continue to expand). But that assumes the combination also goes well. Despite the best intentions, it remains still a risky move (see some of the challenges in MSFT + YHOO: What Would Microsoft Yahoo Look Like?). It’s also not a forgone conclusion, given that Microsoft’s interest underscores the value in what Yahoo already has.

As mentioned, Microsoft said it had “studied” the HP-Compaq deal in 2001 as an example of “a successful merger and integration.” In retrospect, it appears successful but in fact, there was a quite a bumpy ride to get there.

The deal was worth $25 billion and took at least two years to integrate and several years to pay dividends. Indeed, a year after HP bought Compaq, there were persistent questions and criticisms about the deal failing to pay the promised dividends. The HP CEO, Carly Fiorina, who engineered the acquisition, was forced out by the board in 2005, partly because of dissatisfaction about the results of the deal.

By late 2005, roughly three and a half years after the deal, however, HP had secured the top spot in worldwide PC market share. Interestingly, the company has preserved both the HP and Compaq brands, with the latter being repositioned as a somewhat lower-end brand.

By contrast another highly touted merger of two major US competitors in the mobile segment, Sprint-Nextel, still has investors smarting and complaining. Sprint bought Nextel in 2004 for just over $35 billion amid much talk of synergy. However, four years later Sprint is considering writing off $30 billion of “goodwill value,” almost the total value of the merger. In other words, the merger was a total failure for both companies and the synergies never happened.

Will a combined Microsoft-Yahoo emerge as a dominant player, as HP has in the PC market, or will it be more like Sprint, which has failed to realize the promised “synergies?” And closer to home online, who can forget the merger of AOL and TimeWarner, which was similarly supposed to yield synergies that have still yet to materialize?

For more on the Microsoft bid for Yahoo, also see our previous coverage:

Also see discussion from across the web on Blogrunner and Techmeme.

Related Topics: Channel: Industry | Microsoft & Yahoo Search Deal | Microsoft: Business Issues | Yahoo: Business Issues


About The Author: is a Founding Editor of Search Engine Land. He’s a widely cited authority on search engines and search marketing issues who has covered the space since 1996. Danny also serves as Chief Content Officer for Third Door Media, which publishes Search Engine Land and produces the SMX: Search Marketing Expo conference series. He has a personal blog called Daggle (and keeps his disclosures page there). He can be found on Facebook, Google + and microblogs on Twitter as @dannysullivan.

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