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

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:

• Microsoft Makes
  $45 Billion Bid To Buy Yahoo
• Live Blogging
  Microsoft’s Bid For Yahoo Call
• Microsoft: "We
  Love The Yahoo Brand"
• MSFT + YHOO: What
  Would Microsoft Yahoo Look Like?
• Microsoft + Yahoo:
  Recapping Reactions

Also see discussion from across the web on

Blogrunner and
Techmeme.