Microsoft bids $45 billion for Yahoo Software giant offers $31 a share - a 62% premium - in deal that could reorder online ad market. Microsoft's Ballmer: 'Major milestone.

February 1 2008: 5:21 PM EST

NEW YORK (CNNMoney.com) -- Microsoft Corp. made an unsolicited $44.6 billion cash and stock bid for Yahoo on Friday, setting the stage for a deal that would shake up the competitive and lucrative market for online advertising.

Yahoo shareholders would receive $31 a share, which represents a 62% premium over Yahoo stock price one day earlier.

Shares of Yahoo (YHOO, Fortune 500) zoomed and ended the day 48% higher, while Microsoft (MSFT, Fortune 500) tumbled 6.6%.

Steve Ballmer, Microsoft's chief executive, called the move the "next major milestone" for the software giant.

"We are very, very confident this is the right path for Microsoft and for Yahoo," Ballmer said.

Microsoft hopes to close the deal by the end of the year. Ballmer said that Microsoft has been in "off and on" talks with Yahoo for 18 months and said he called Yahoo CEO Jerry Yang Thursday night to tell him the bid was coming.

A Microsoft-Yahoo combination would create a powerful number two player in the online search business, which Google commands. It would also be one of the biggest tech deals in years, on a par with Hewlett-Packard's $25 billion acquisition of Compaq in 2002.

Microsoft announced the bid early Friday. In a statement, the company said the offer allows Yahoo shareholders to elect to receive cash or a fixed number of shares of Microsoft common stock, with the software giant's offer consisting of one-half cash and one-half Microsoft common stock.

In a statement, Yahoo acknowledged receipt of the offer and said its board would evaluate the proposal "carefully and promptly."

Searching for solutions

Both Microsoft and Yahoo have fallen far behind rival Google (GOOG, Fortune 500) in the lucrative field of Internet search. Yahoo's earnings and share of the online search market have badly trailed Google.

Google reigns over 58.4% of the U.S. search market, while Yahoo has 22.9% and Microsoft's share is just 9.8%, according to comScore, a research firm that tracks Internet traffic.

The combined forces of Microsoft and Yahoo would also make a stronger force in online display advertising - the type of targeted banner ads that Yahoo is known for.

In a letter it sent to Yahoo's board of directors, Microsoft disclosed it had explored a Microsoft-Yahoo deal a year earlier, only to be rebuffed by Yahoo, which said at that time it was confident of the "potential upside" for Yahoo from operational changes it planned.

"A year has gone by, and the competitive situation has not improved," said Ballmer.

On Thursday, former Yahoo CEO and current Chairman Terry Semel, who opposed an earlier approach Microsoft made last year, resigned from the Yahoo board.

Yahoo announced Tuesday it would lay off 1,000 employees by mid-February, citing what CEO Yang described as "headwinds" facing the company. It also reported lower fourth-quarter earnings that still beat Wall Street's now modest expectations for the firm, but it gave a 2008 revenue forecast that disappointed analysts.

"Last year, Yahoo told investors it needed more time to get on the right track," says UBS analyst Benjamin Schachter. "But you only get a certain amount of time to turn things around."

Gunning for Google

Recently, Google has run into problems. It reported fourth-quarter earnings on Thursday that fell a penny a share short of forecasts. The company also announced a slowdown in its revenue growth, attributed partly to difficulty in selling ads on social networking sites.

A Google spokesman, Matt Furman, declined to comment on Microsoft's move on Yahoo. "It would be premature to comment at this point," he said.

Google shares have fallen 24% since hitting a record high $747.24 in early November. But Yahoo shares have lost more than a third of their value over the same period.

Still, online advertising, particularly ads tied to Internet search, is by far the fastest growing part of ad spending. That's caused problems for traditional media, which have seen ad spending fall.

Microsoft said it projects the online advertising market to grow from over $40 billion in 2007 to nearly $80 billion by 2010.

In the letter to Yahoo's board, Microsoft said a tie-up would achieve economics of scale while allowing combined research and development efforts to achieve breakthrough products, particularly in the growing areas of online video and mobile Internet connections.

Microsoft said it intends to offer significant retention packages to Yahoo engineers, key leaders and employees across the firm. It said it believes the proposed combination would receive all necessary regulatory approvals.

Shortly after the announcement, a U.S. Justice Department spokesperson said that its "antitrust division is interested in looking at the competitive effects of the [Microsoft and Yahoo] transaction." But with Google's strong lead in the search industry, analysts said it is highly unlikely Microsoft's proposed deal would violate antitrust laws.

Stifel Nicolaus analyst George Askew gives the deal an 80% change of being completed.

"This acquisition offer is a bear hug - and the two companies may well come to terms on a deal at a modestly higher price than the $31 offer," Askew said in a written note.

But some analysts say the integration of the two companies could be tricky to pull off. For one, Microsoft and Yahoo use different platforms to run their search engines, and they would have to decide which one to use.

Friday, February 01, 2008 at 6:21 PM