News

Gates Says Yahoo "Needs Scale"

Scale was behind Microsoft's interest in Yahoo

• By Becky Nagel
• 02/11/2008

Today at Microsoft's Office System Developer Conference (OSDC) in San Jose, Calif., Microsoft Chairman Bill Gates commented on what he thinks Yahoo got right -- and wrong -- just as Yahoo formally rejected the Redmond, Wash.-based company's initial offer.

In a response to a question asked by Microsoft Office evangelist Jay Paulus at this morning's OSDC keynote, "What's Up with Yahoo?", Gates replied:

Yahoo has done great work. I particularly point to the engineering work they've done. And there was always this question of, should they try to be just a pure media company or should they really have logged strong engineering, and Jerry [Yang] really kept the emphasis on engineering. They did good work. But in an ad model, you need scale. And it's a tricky question of whether only one company has that scale. How to get the maximum level of investment to take that very good engineering and combine that with the engineering that we've done. So we think that's a way to invest more in the R&D.

There is a strategy where you drive toward being a media company and you take functions and you give up the engineering to someone else. We don't believe in that. The core is going to be engineering, and you've got to get it into a level of scale so that you can go and challenge to become the number one in that space.

It's that scale that has interested Microsoft in Yahoo in the first place. As stated repeatedly since Microsoft announced its intent to acquire Yahoo on Feb. 1, Google dominates both online search and the ad revenues that go with it.

According to an IDC study released this morning, Google has 23.7 percent of Internet advertising revenue in the U.S., which totaled approximately $25.5 billion in 2007.

"If a merger between Microsoft's new media business and Yahoo! would come to pass, the combined entity would have a net U.S. advertising market share of about 17 percent," Karsten Weide, program director for IDC's Digital Marketplace, said in a prepared statement announcing the research results. "It would not quite bring Microsoft-Yahoo to where Google is in online advertising in the U.S., but it would give them a much better fighting chance than if they went it alone."

However, as noted today by NPR and others, the merger would give Microsoft more than 90 percent of the Web mail and instant messaging market, according to Forrester Research.

Microsoft's proposed acquisition of Yahoo was formally rejected by the Sunnyvale, Calif. company this morning (although the pending rejection was widely reported following a Yahoo shareholder meeting Friday). In a statement, Yahoo said that Redmond's initial offering of $44.6 billion, or approximately $31 per share, diminishes the company's value.

"After careful evaluation, the Board believes that Microsoft's proposal substantially undervalues Yahoo including our global brand, large worldwide audience, significant recent investments in advertising platforms and future growth prospects, free cash flow and earnings potential, as well as our substantial unconsolidated investments," the company said in the statement. "The Board of Directors is continually evaluating all of its strategic options in the context of the rapidly evolving industry environment and we remain committed to pursuing initiatives that maximize value for all stockholders." At the time, the initial offer was more than 60 percent above the company's share price.

In response to the rejection, Microsoft released a statement this afternoon that reads, in part: "It is unfortunate that Yahoo has not embraced our full and fair proposal to combine our companies...The Yahoo response does not change our belief in the strategic and financial merits of our proposal. As we have said previously, Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo's shareholders are provided with the opportunity to realize the value inherent in our proposal."

For additional analysis of the proposed merger and what it may mean for enterprise IT, see the online preview of Redmond magazine's March cover story, "Can MicroHoo Take on Google?"

--Additional reporting by John Waters