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Saturday, May 5, 2007 - Page updated at 12:00 AM

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Hot rumors of Microsoft-Yahoo! merger, then cold splash of reality

Seattle Times technology reporter

The courtship was reportedly on again and, after 246 million shares changed hands Friday, off again.

Reports first surfaced Friday morning in the New York Post and later The Wall Street Journal that executives from Microsoft and Yahoo! were "taking a fresh look at a merger" to better compete with Internet rival Google.

Neither company would confirm the rumors, attributed by both papers to unnamed sources and repeated on Web sites around the world. Shares of Yahoo! jumped more than $5 at one point and finished the session at $30.98, up 9.9 percent, or $2.80, on trading volume more than 10 times the recent daily average.

Technology pundits spent Friday buzzing about what a Microsoft acquisition of Yahoo! — which, at an estimated $40 billion to $60 billion, would have been by far Microsoft's largest — could mean to the industry.

Then, just after the stock markets closed, The Journal doused its earlier report. Again citing unnamed sources, it reported online that "in recent months" Yahoo! and Microsoft had talked about a merger or "some kind of matchup that would pair their respective strengths," but that the merger talks are "no longer active."

Some lesser partnership remains a possibility, according to The Journal story.

With that news, Yahoo! shares gave back 43 cents in after-hours trading. Microsoft shares dropped 41 cents, 1.3 percent, in regular trading to close at $30.56 Friday.

Yahoo!-Microsoft merger talks have been a topic of rumor and speculation before and the companies have worked together in the past. They integrated their instant-messaging systems, allowing people to communicate regardless of where they had an account. They also used the same platform for making money off of online-advertising sales until last year. Since then, each company has developed and launched its own system.

Effect on stocks

Matt Rosoff, an analyst at Kirkland-based Directions on Microsoft, was surprised that the stock markets reacted strongly to the rumored acquisition, which, in his mind, does not make sense for Microsoft.

"I don't see Microsoft paying $40 billion to $50 billion for an outright acquisition," he said Friday morning, adding later in the day after the story was updated, "You just kind of have to look at the logic before jumping to conclusions."

Rosoff and other analysts said the potential negatives of a merger outweigh what the companies would gain in their battle with Google for a larger share of the Internet-advertising pie — predicted to hit $31.4 billion globally this year, up 28 percent.

There's also plenty of potential upside.

Brent Thill, an analyst with Citigroup, said a merger with Yahoo! would "jump-start" Microsoft's online-business unit, which he called the company's "biggest lagging asset." That unit lost $200 million in the company's most-recent quarter.

Microsoft and Yahoo! would have a combined U.S. online audience greater than 135 million people, according to the most recent figures from Nielsen//NetRatings. That's too big for advertisers to ignore and big enough that the companies could ask for a premium price, Rosoff said.

"That would be a pretty powerful and a good response to Google's acquisition of DoubleClick," Rosoff said. Google agreed last month to buy the online display-advertising provider for $3.1 billion.

But aligning the various Internet services that Yahoo! and Microsoft provide to attract users would be a challenge.

A merged Yahoo! and Microsoft would face the tough task of integrating an extensive and growing suite of branded Internet services from each company, including e-mail, Web search, small-business services, financial news and online video.

They also have substantially different corporate cultures and leadership teams — potential stumbling blocks for any mega-merger.

"Just sorting out the details of how Yahoo! would be amalgamated into Microsoft is going to take a year and a half or two years — just to figure out who's the boss — let alone how to then go attack the market leader," said Kip Kniskern, a contributor to LiveSide.net, which tracks Microsoft's Internet-services efforts.

Search advertising

In the category of search advertising — the source of most of Google's revenue — a merged Microsoft and Yahoo! would still be coming from behind. The search-advertising business involves selling text ads that are to be displayed next to Internet search results.

In March, 54 percent of U.S. Internet searches were performed with Google. Microsoft and Yahoo! had a combined 32 percent.

While a merger may be off the table, some analysts are still expecting some kind of partnership announcement from the two companies next week. They certainly have the opportunity:

Yahoo! Chairman and Chief Executive Terry Semel is scheduled to speak at Microsoft's Strategic Account Summit for advertisers in Seattle on Wednesday. Microsoft Chairman Bill Gates is on the agenda Tuesday.

One note: Google CEO Eric Schmidt spoke at the event in 2005 and his company is no friendlier with Redmond.

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com

Copyright © 2007 The Seattle Times Company

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