Microsoft and Yahoo have common foe

By Scott Moritz, writer

The yelling phase of the proposed Microsoft/Yahoo merger got a bit louder as Yahoo (YHOO) turned in good numbers ahead of the deal negotiation deadline.

In the wake of a solid first quarter performance from Yahoo Tuesday, Microsoft (MSFT) chief Steve Ballmer said his company was standing pat on its original $31 a share unsolicited takeover offer. Microsoft has given Yahoo until Saturday to come to the table with a counter proposal, or face a proxy battle.

“We know what Yahoo is worth to us. We offered a lot of money: $44 billion,” Ballmer said in Milan Wednesday, according to a Reuters report. “If their board thinks that’s fair, great. If not, we’ll move forward,” Ballmer said.

Ballmer is likely waiting to see what Yahoo does come Saturday — the end of the three-week period Microsoft gave Yahoo to consider its options. Microsoft has threatened to start a proxy fight if the two companies fail to come to terms. This would open up an ugly process where Microsoft takes its appeal to shareholders calling for the ouster of Yahoo’s top management and key board members.

Last week, Yahoo rejected the Microsoft bid for a second time saying the proposal undervalued the company. Yahoo also held discussions with Time Warner (TWX) about a deal involving a 20% stake to be held by Time Warner in exchange for AOL and a pile of cash for share buybacks.

But many analysts and investors favor a more amicable conclusion that seems to call for a slightly sweeter offer from Microsoft, either a price higher than $31 a share or an all-cash offer.

Yahoo’s earnings Tuesday, while far from dazzling, did show that the company is not deteriorating as quickly as Microsoft may have suggested. Both companies, however, continue to lose business to Google (GOOG) a point that industry observers say makes the Microsoft Yahoo merger a growing necessity.

The trouble for Yahoo is that it must convince Microsoft to outbid itself, says Darren Chervitz analyst with the Jacob Internet Fund, a big Yahoo investor.

It’s well known that Yahoo has long been losing Net search traffic to Google. And by passing on the acquisition of Facebook last year, they’ve done little to improve their competitive position, says Chervitz.

And for its part, Microsoft has gained very little traction on the Internet. Efforts like MSN mail and .Net haven’t exactly hit any jackpots. Meanwhile, Google has expanded into Microsoft’s software domain with word processing and other office applications available to users online for free.

An even bigger threat to Microsoft is Google’s push into wireless applications. The Google-sponsored Android project hopes to create an operating system for a new generation of mobile devices, a direct threat to Microsoft’s Windows Mobile system. Microsoft can’t easily afford to miss the mobile Internet opportunity, says Chervitz.

“Yahoo,” says Chervitz, “is the only acquisition that gets Microsoft into the game.”