Microsoft (MSFT) signaled its ready to play hardball with Yahoo (YHOO) in its bid to acquire the Internet giant, and antitrust regulators are scrutinizing a trial advertising partnership that Google (GOOG) and Yahoo recently struck.

Microsoft put some substance behind its threat to take its three-month-old buyout offer to Yahoo shareholders by naming 13 people as potential candidates to the company’s board, according to Thursday’s The Wall Street Journal.

The list includes former Nextel Partners CEO John Chapple; Edward Meyer, former chief of Grey Global Group; Jaynie Studenmund, the former chief operating officer at Overture Services, a company Yahoo acquired a few years ago; and former Adelphia Chief financial officer Vanessa Wittman, the Journal reported.

Microsoft’s tougher stance comes amid news reports that the Justice Department is looking into Yahoo’s outsourcing of some of its advertising to Google. The companies’ two-week trial ended Wednesday. Yahoo has said it involved about 3% of its search results.

Yahoo has been looking for ways to reduce the cost of operating its search service and, in an effort to thwart Microsoft, to demonstrate it can thrive as a standalone business. But the cooperation between the No.1 and No.2 two search engine shops immediately raised anticompetitive flags when the pact was announced earlier this month.

Google says it “informed the Justice Department before we launched this test, and we have been responsive to their questions about it,” according to the Los Angeles Times. Yahoo said it too had given the Justice Department a heads up prior to the test, according to the Times report.

Microsoft has given Yahoo until Saturday to come up with a counter proposal or answer to its $43 billion takeover offer.

By Yi-Wyn Yen

Google’s shares have lost a third of their value since the start of the year, and concern is growing whether the small text ads Google serves are partly to blame. That will be one of the top things Wall Street will pay attention to when Google (GOOG) reports earnings Thursday after the close of trading.

“Revenue growth and paid clicks. That is what is on everyone’s minds,” says Imran Khan, an Internet analyst with J.P. Morgan.

In late February, comScore released a controversial report that had many analysts convinced that Google was not immune to a recession. The comScore report suggested that Internet users in the United States were clicking on Google ads less frequently. Some analysts began slashing their price target on Google, which gets 97% of its revenues from online ads, after the report showed that Google’s ‘paid clicks’ were flat in both January and February from the same period a year ago.

Tuesday evening comScore issued its latest report that showed Google’s paid clicks grew 3% in March year-over-year. But this time, analysts remain more cautious of the comScore’s numbers and warned investors against reading too much into the data. “We…believe that it is most useful for spotting trends,” wrote UBS analyst Ben Schachter in a report.

Is the slowing growth of Google’s paid clicks due to a weaker economy or because the company is actively managing the volume of its own ads? Google, which does not give forecasts for future performance, has said it is the latter and it is working on weeding out the poor quality clicks.

If that is the case, Google will still have to prove that its quality control initiatives translated into higher-revenue growth for the first quarter. Google believes that by placing fewer ads, it will be able to charge higher rates per ad.

Schachter is skeptical that the revenue generated by fewer, higher-quality ads will make up the difference. “Google may have made some pricing improvements, but we don’t believe they will be enough,” he wrote.

“We simply disagree with the notion that pricing out the lower quality advertisers will somehow result in higher quality advertisers paying higher rates in the near-term,” he added.

Besides paid click revenue, there will be plenty of other topics to discuss about Google’s first quarter. In an effort to push for open standards among mobile operators, Google entered the 700 MHz spectrum auction. In the second half of the year, Taiwanese manufacturer HTC is set to release a handset that uses Android, Google’s own mobile operating system.

The search giant also closed its $3.1 billion acquisition of DoubleClick, the industry’s top ad server. Analysts will also pay particularly close attention to Google’s integration plans for DoubleClick. In April, Google laid off a quarter of DoubleClick’s 1,200 U.S. employees.

The DoubleClick deal is largely seen as a way for Google to grow its display advertising potential. Wrote Citi analyst Mark Mahaney, “We believe that traction with the DoubleClick deal - along with mobile Internet and YouTube monetization progress - can provide material stock catalysts” for the second half of 2008 and first half of 2009.

By Yi-Wyn Yen

Tick tock.

One week has passed since Microsoft CEO Steve Ballmer set a three-week deadline for Yahoo to accept the software giant’s $42 billion offer, yet the companies are no closer to reaching an agreement than they were last Saturday.

Should they fail to reach an agreement by April 26, Ballmer will mount a proxy fight to oust Yahoo’s board of directors. But before things get truly hostile, Microsoft (MSFT), will find ways tighten the screws on Yahoo (YHOO).

Analysts speculate that the most likely scenario is for executives from both parties to meet again for the first time since the letter went public and strike a deal.

While the software giant is debating bringing News Corp. (NWS) on as a bidding partner to buy Yahoo, the complexities of engaging three parties and reaching an agreement swiftly make that scenario unlikely. Despite all the numerous wheeling and dealing among Internet giants, “We still think Microsoft will prevail,” wrote UBS analysts Ben Schachter and Heather Bellini in a note to clients.

Yahoo, however, isn’t going down without a fight. The company publicly rejected Redmond’s initial offer to buy out the company at $31 a share because it is convinced the bid is too low. The shares are now valued at $29. In an effort to find white knights, Yahoo has sought a three-way alliance with Time Warner (TWX) (which owns Fortune and CNNMoney) and Google this week. Time Warner would offer cash and fold AOL into Yahoo in exchange for a stake. Yahoo meanwhile is testing Google’s search ad service.

Such an alliance is shaky at best. A Yahoo-Google combination may face regulatory problems. And Yahoo’s shareholders may not find a Yahoo-AOL deal nearly as attractive as a Microsoft-Yahoo offer.

Industry watchers believe that Yahoo’s latest efforts are pure posturing. “They are setting up a textbook case to attract a higher price from Microsoft. It’s a classic diversionary tactic,” says James Owers, a professor of corporate finance at Robinson College of Business at Georgia State. “They were probably very unhappy with Ballmer’s letter and raced off to have discussions with AOL. It’s an attempt to say, ‘Hey, don’t bully us and threaten us with a lower price.’ “

Microsoft could attempt to walk away from the bid in an effort to make Yahoo’s shares drop dramatically. Oracle CEO Larry Ellison employed a similar tactic when he pursued PeopleSoft. Yahoo’s stock has traded 51% higher on average than when it last traded at $19.18 prior to Microsoft’s offer. Microsoft is offering a bid that’s worth a 62% premium of Yahoo’s shares. But a scenario to arm-twist Yahoo could backfire. “It’s the most aggressive move to walk away and come back with a lower bid. That would get the egos on the Yahoo side pretty enraged,” Owers says.

Ballmer is determined to buy Yahoo, and most likely, will get what he wants even if he ultimately pays a little bit more. Some Wall Street analysts expect Microsoft to offer Yahoo between $32 and $35 a share. Ballmer has been vocal about his intent to catch up with Google in the online advertising market, and firmly believes that combining forces with Yahoo is the only chance Redmond has to succeed. Much like the way the company poured billions into its Xbox gaming division to compete with Sony Playstation, Microsoft will do the same to go after Google. Microsoft has $21 billion in cash and is willing to issue debt to finance the deal that’s worth more than $40 billion.

“Ballmer offered a 62% premium. He wouldn’t have done that if he was just kicking the tires around,” Owers says. “That’s considered a blowout bid. And a blowout bid bid signals a determination to prevail.”

By Yi-Wyn Yen

Yahoo and Time Warner’s AOL are negotiating a deal to combine their Internet operations, a source told Fortune.

The news was initially reported in the Wall Street Journal, which stated that Time Warner (TWX) would fold AOL into Yahoo and make a large cash investment for a 20% stake of the combined company. In return, Yahoo would repurchase several billions of its shares in the mid-$30 range. Time Warner is also the parent company of Fortune and CNNMoney.com.

For Microsoft, this means war. The Journal and New York Times have also reported that Microsoft (MSFT) is now in talks with News Corp. (NWS) for a joint bid for Yahoo. Last Saturday, Microsoft CEO Steve Ballmer sent a strongly-worded letter to Yahoo’s shareholders that it should accept its offer within three weeks or face a proxy fight to nominate a new board of directors.

Yahoo is also looking at a possible advertising deal with Google (GOOG). Just hours before the news leaked of Yahoo’s advanced talks with AOL, the Internet portal announced that it would run a preliminary two-week test to run Google’s search advertising.

Yahoo, which has rejected Microsoft’s bid worth $31 a share, is hoping that a partnership with AOL and a possible advertising deal with Google, will be a more attractive offer to its shareholders. There’s no guarantee that Yahoo’s shareholders will go along with the deal if Microsoft comes back with a higher offer.

Many industry watchers continue to believe that accepting a deal with Microsoft is the best solution for Yahoo. “We continue to believe reaching a mutual agreement with Microsoft would be the best way for Yahoo to potentially extract a higher bid,” wrote UBS analyst Ben Schacter in a note late Wednesday. “The alternative would be for Yahoo shareholders to tender, although this process would not be as expeditious as if the two sides were to come to terms, and could involve a lower offer price, making the battle potentially even more protracted.”

By Yi-Wyn Yen

Microsoft signaled Friday that it could rescind its offer to buy Yahoo at $31 a share.

Microsoft (MSFT) and Yahoo (YHOO) executives met earlier this week but the talks ended in a standstill. Microsoft execs, who had earlier hinted that they would not raise their bid, refused to pay the $40 per share that Yahoo demanded, a source familiar with the matter told Fortune.

A Yahoo spokeswoman declined to comment.

The source said that Microsoft doesn’t plan to revoke its offer, but is merely using a tactical maneuver called “market signaling” to put pressure on Yahoo’s board of directors. Microsoft is broadcasting to Wall Street that Yahoo’s stock would become vulnerable it if withdraws its bid.

The software giant has said that it does not need to raise its offer because it doesn’t believe Yahoo has any alternative but to accept the deal. Yahoo has repeatedly stated that Microsoft’s offer significantly undervalues the company and formally rejected the offer in February.

After Reuters reported Friday that Microsoft was “evaluating” its offer, Yahoo shares slipped 6% in after-hour trading. The software giant made its $44.6 billion offer on Jan. 31. The deal is now valued at about $42 billion.

By Yi-Wyn Yen

Alibaba Group, the Chinese Internet giant that is part-owned by Yahoo, is reportedly in advanced talks with investors to buy back the shares owned by Yahoo, according to a Wall Street Journal report.

Concerns of a Microsoft (MSFT) takeover have prompted Alibaba to look for possible buyers as the company prepares to maintain its independence. While Alibaba is not pushing for a Microsoft sale, the company believes it can invoke the “right of first offer” clause from its 2005 agreement with Yahoo (YHOO) to buy back Yahoo’s 39% stake. Although the Alibaba group is private, Yahoo’s stake in it should be worth upwards of $1 billion.

Alibaba’s move comes on the heels of Yahoo’s presentations with major shareholders this week. Yahoo executives are promoting some of its crown jewels, including its stake in Alibaba, to convince Wall Street that it’s worth more than Microsoft’s $31 a share bid. On Tuesday Yahoo released a rosy presentation that showed its plans to nearly double operating cash flow from $1.9 billion to $3.7 billion within three years. At $27.23, Yahoo’s stock fell by 1.5% in mid-day trading Wednesday.

UBS analyst Benjamin Schachter called Yahoo’s revenue projections for the next two years “very aggressive targets” and believes that an offer of $34 a share would be acceptable. In a note to clients he wrote, “We think the company hasn’t earned the benefit of the doubt given the operating history of the past few years.”

Meanwhile, Alibaba.com has lost nearly a fifth of its value since it listed in Hong Kong last November (that’s part of a broader market drop; the Hong Kong Hang Seng index is off some 30% from its November 2007 high). Though Alibaba.com, a business-to-business site that is part of Alibaba’s vast portfolio, reported profits that have more than quadrupled on Tuesday, the stock fell below its IPO offer price for the first time that day. Shares closed at HK $12.2o on Wednesday.

By Yi-Wyn Yen

Microsoft on Friday bought Rapt, a San Francisco-based online ad management firm, for an undisclosed sum. The move came three days after Google cleared its $3.1 billion acquisition of the ad serving company DoubleClick.

Both acquisitions are a sign of the heated battle between the search giant and the software giant for a share of the growing display advertising market. Microsoft (MSFT) has made aggressive moves into that market ever since Google (GOOG) announced its intention to buy DoubleClick last April. Since then Microsoft has spent $6 billion to buy aQuantive, an ad network that competes with Google’s AdSense, and last month made an unsolicited offer of more than $40 billion to take over Yahoo (YHOO). The Wall Street Journal reported that executives from both Microsoft and Yahoo met near Yahoo’s headquarters in Sunnyvale on Monday to have informal talks for the first time.

Microsoft sees its newest acquisition as a way to compete with Google’s DoubleClick, which serves ads for both advertisers and publishers. By adding Rapt, an inventory management software service for publishers, Microsoft now works with half of the top 25 online publishers, including Yahoo, CNET, and Fox Interactive Media (NWS).

“This is certainly an interesting and relevant move for Microsoft,” Rapt CEO Tom Chavez told Fortune. “Our approach is that publishers are customers. They need to know what their inventory is, where they’re losing and making money. We’re betting that publishers are going to need access to the technology to manage that. Microsoft’s approach is that we need to give folks choices.”

By Yi-Wyn Yen

With the European Commission blessing Google’s $3.1 billion purchase of ad network DoubleClick, the question on everyone’s lips is, what now?

After nearly a year of waiting to close its largest acquisition, Google chief executive Eric Schmidt is wasting no more time folding DoubleClick into the company. “That work will begin in earnest now,” he said in a blog post.

Schmidt said that the Mountain View-based company will begin the integration process by seeing how many of its nearly 17,000 employees overlap with the 1,500 at DoubleClick. Google (GOOG) says it will sort out the staff integration by early April and that there may be layoffs. Schmidt did not indicate how many jobs will be cut and if the company plans to move DoubleClick, headquartered in the media capital of New York City, to the Googleplex.

Beyond Googlers with jobs at stake, many industry watchers wonder how a Google-DoubleClick merger will change the online advertising landscape. Google, which built its business with search advertising, can now aggressively move into the graphical advertising market with DoubleClick. A Google spokesperson says the company is currently not providing further details of the integration.

Privately, some ad networks say they fear a two-headed Googzilla. Google’s DoubleClick is one of the leading companies which targets banner ads for both advertisers and publishers with its Dart technology platform. Google’s AdSense is the leading ad network that supplies text-based ads for both advertisers and publishers. Some speculate that Google won’t keep DoubleClick as a separate entity and will join to create a super-sized ad network. These people say they worry that Google now has too much information and can use it to squeeze out other players like AOL (TWX) and Yahoo (YHOO) that primarily focus on the display ad business.

Even if an explicit integration doesn’t happen, a Wall Street analyst estimates that Google will instantly gain a huge share of the graphical ad market, which will reach an expected $28.6 billion by 2010. “Google will now have behavioral data from search, e-mail, video, and web usage on network sites,” JP Morgan analyst Imran Khan wrote in a report. “We believe this will allow the company to provide much better ad targeting, leading to increased CPMs on DoubleClick sites.”

Microsoft (MSFT), Google’s chief opponent of the DoubleClick must speed up its proposed takeover of Yahoo if it has any hopes of catching up to Google. A Microsoft spokesperson reiterated on Tuesday that Google’s acquisition of DoubleClick justifies a need for a powerful No. 2 player.

That echoes what Brad Smith, Microsoft’s general counsel, said last month: “The reaction from publishers, which includes a lot of the media companies, has been very positive. They have been encouraging us to make this kind of acquisition…. This is the right kind of step that is going to create a more compelling and competitive number two in the marketplace.”

By Yi-Wyn Yen

European regulators are expected to clear Google’s $3.1 billion purchase of online ad company DoubleClick, as early as Tuesday.

Despite Google’s dominance in online advertising, which will likely increase once it acquires DoubleClick, regulators argue there’s still plenty of room for competition in the nascent market. Microsoft hopes to challenge Google by combining forces with Yahoo. However, a potential Microhoo may run into resistance from European regulators who view Microsoft as a software market abuser .

While Google (GOOG) would not speculate on the ruling, industry watchers have been expecting the European Commission to approve the merger since the Federal Trade Commission cleared the deal of antitrust issues in December. A Google spokesman in London said the company anticipates an announcement sometime before the April 2 deadline because European regulators typically do not wait until the final day to make a ruling.

An EC approval removes the last obstacle Google needs to complete the DoubleClick acquisition.

Privacy advocates and rivals like Microsoft (MSFT), have been trying to block merger. Privacy watchdogs have warned that a combination of Google, which keeps logs of a user’s searches, and DoubleClick, a technology platform that tracks which sites a person visits, would be disastrous. But both the FTC and EC have stated that it will only rule on antitrust issues, not privacy concerns. Microsoft has argued that a merger with DoubleClick, which serves ads, would make Google too powerful and prevent competitors from serving and selling ads.

Despite Microsoft’s efforts, the EC is expected to side with Google. The Mountain View, Calif.-based company has argued that nothing prevents one customer from switching from one ad platform to the next. If you want to go to Microsoft or Yahoo (YHOO), no one is stopping you. When Viacom (VIAB) dumped Google to strike a major ad deal with Microsoft, Google was quick to spin it as a positive. “We have argued all along that the online advertising space is highly competitive and that there are no barriers to switching,” a Google spokesman said last December about the deal.

Others agree that Microsoft had a weak case. “The possibility that Google could increase its market power with DoubleClick is quite limited. Internet advertising is a very active market,” said Juan Delgado, a former antitrust official who now is a research fellow at Bruegel, an independent economic think thank in Brussels. “Google is a very powerful player in online advertising, but there’s no secret to this business. It’s similar to MSN or Yahoo. Google’s just more successful.”

Some analysts say that Microsoft’s bid to buy Yahoo for more than $40 billion could raise tougher antitrust concerns, especially in Europe. Last month Europe’s antitrust director Neelie Kroes slapped Microsoft with a record $1.3 billion fine for overcharging competitors for information on how to develop products for Microsoft’s dominant Windows operating system.

“Microsoft has a long history of abusing its market power in certain markets. Google, on the other hand, doesn’t,” said Rebecca Arbogast, a regulatory analyst with Stifel Nicolaus.

Both advertisers and publishers have said that they would like an alternative to Google, even if that means combining the forces of No. 2 and No.3 Yahoo and Microsoft. Should the marriage happen, Google will likely lead an effort to oppose it. Beyond a combined advertising network, MicroHoo would share other broader services that include 90% of free e-mail accounts and a majority of instant messaging accounts, portals and browsers.

Said Arbogast: “The European Commission is concerned about the concentration in online advertising. They are also concerned about privacy. They have a general unease about these American companies bulking up and that the U.S. [government] hasn’t been more vigilant. They’re suspicious of Microsoft and view it as a bad apple. It’ll be interesting to watch their analysis if Microsoft and Yahoo strike a deal.”

By Yi-Wyn Yen

Ten years ago, Microsoft bought one of the most powerful ad networks of the first dot com boom - LinkExchange - for $265 million. At that time, the service provided free advertising for more than 1 million Web publishers, including eBay (EBAY). But after nine years of trying to turn it into a small business portal, Microsoft (MSFT) shut it down.

Now one company wants to turn Microsoft’s trash into an online treasure. AdBrite, a network that places paid ads on Web sites, has brought back the free ad exchange service and repackaged it as Spottt.

AdBrite even brought in a former LinkExchange cofounder to help create Spottt. “Back in 2005, I was talking to Tony Hsieh, one of the cofounders who is now the CEO of Zappos. I told him I couldn’t believe Microsoft shut down LinkExchange,” AdBrite cofounder Philip Kaplan said. “Of course this was before ad networks existed and everyone had their own Web site. Now something like [LinkExchange] would be the most valuable thing. I asked Tony to help me rebuild it, and he agreed.”

More than 2,000 web publishers and bloggers have joined Spottt since the service launched about three weeks ago. Spottt users prominently place a small, square image on their site, which then rotates ads for other sites that also use Spottt. The service is free, and Kaplan says AdBrite plans to make a profit by eventually rotating paid ads whenever there’s an opening. (When your Spottt ad shows up twice on a site, you return the favor by showing that site’s ad once.)

Plus, anyone with a Web site is a potential paying advertiser. Spottt ads are placed randomly throughout the Internet. AdBrite is banking that some Spottt users will eventually pay to better target their ads.

Kaplan says AdBrite is testing Spottt to be used on social networking sites like MySpace (NWS). “An 18-year-old kid with a band profile on MySpace wants people to come to his site, but he’s not going to pay for advertising. Spottt will be the world’s first solution that will let you advertise your MySpace page for free. When it does, Spottt will take off like wildfire,” Kaplan predicts.

But if this is such a great service, why did Microsoft kill it in the first place? A Microsoft representative said the flashing banner ads that popped up on LinkExchange were becoming unpopular at that time, while relatively unobtrusive text ads that appeared on search engines like Google (GOOG) were gaining acceptance.

“LinkExchange was before its time,” said Mike Hurt, director of ad product planning and strategy for Microsoft. “AdBrite’s done a good job of making their ads standardized.”

Hurt says now Microsoft is building its ad business around aQuantive, the ad company they bought for $6 billion last year. DRIVEpm, an ad network within aQuantive, sells ad space for the top 250 publishing sites. Microsoft is also hoping to buy Yahoo (YHOO) for $45 billion to better compete with Google.

“Microsoft didn’t think that advertising on small Web sites was a worthwhile endeavor. Now they’re trying to get the small publishers again,” Kaplan said. “It’s very unfortunate. Microsoft could have been very, very big.”