Why Google Might Want a Microsoft-Yahoo Merger

By Portfolio.com

Google has exhibited considerable anxiety over Microsoft's effort to buy Yahoo, bad-mouthing the deal from its Silicon Valley headquarters and unleashing its lobbyists in Washington.

A growing number of analysts and others on Wall Street, however, are starting to ask, Why bother? They believe that a Microsoft-Yahoo merger could be a very good thing for Google—especially if it's preceded by a bitter takeover battle, as now seems likely.

"Whatever happens, it's going to be a win-win for Google," said Jim Friedland, an analyst at Cowen and Co. "We think the integration process for Microsoft and Yahoo is going to be absolutely brutal. There's going to be a turf war."

As tech blogger and former Microsoft evangelist Robert Scoble said, "If you put two turkeys together, you don't get an eagle."

Even if the merger wins regulatory approval, it could be years before Microsoft successfully integrates Yahoo and begins to realize the anticipated cost savings and economies of scale the deal promises. With both companies distracted by the tie-up, Google could seize the opportunity to woo disaffected engineers, increase its dominance in search and text advertising, and build a lead in display ads.

"Google is going to try to take advantage of the integration issues," commented UBS analyst Ben Schachter. In particular, he said, Google could shore up its display ads: Unlike text-based advertising, display advertising—larger spots that incorporate photos, video, or sound—is one of the few areas where Google does not dominate.

"Neither Microsoft or Yahoo has been executing well," Schachter added, "and there is certainly no guarantee that they are going to be able to execute as a combined company any better than they did as separate companies. In fact, there is a real possibility they could execute worse."

Cantor Fitzgerald analyst Derek Brown echoed that view, warning that a combined Microsoft-Yahoo runs the risk of falling even further behind Google, thanks to the sheer size, length, and complexity of the deal.

"We think the combined company could actually lose market share to Google and others over time," Brown said, "as product, infrastructure, and cultural integration challenges divert attention and resources from the critical areas of innovation and customer service."

Brown added that the "red tape, size, and bureaucracy" associated with the merger could "increase time-to-market for new products and services," and that he holds "little hope that a merged Microsoft-Yahoo entity would radically alter the current competitive landscape."

William Blair analyst Troy Mastin agreed that Google might secretly welcome the merger, or at least a protracted takeover battle, followed by a long regulatory review and an even lengthier integration process.

"It's a sound theory," Mastin said, adding that Google will be looking to cherry-pick discontented top Microsoft and Yahoo engineers, "who might be uncertain about what the merger will mean for them."

Even before the Microsoft offer, many Yahoo employees had been preparing their résumés after the company announced its intention to lay off about 1,000 people in job cuts that began today.

Publicly, Google has responded to Microsoft's offer by trying to delay the process, raising antitrust concerns and seeking to distract both Microsoft and Yahoo by floating Yahoo exit strategies. One idea: a potential search partnership with Google.

One day after Microsoft announced its offer, Google senior vice president David Drummond warned that Micosoft seeks "to establish proprietary monopolies" and urged regulators to "thoroughly" scrutinize the deal.

But Drummond's broadside struck many people as hypocritical. For one thing, Google itself dominates the Web search landscape, with nearly 70 percent of the market. For another, Google C.E.O. Eric Schmidt has floated the idea that Yahoo, its closest rival, could outsource its search business to . . . Google.

"Google's argument is somewhat facetious, given their market position," said Roger Kaye, president of research firm Endpoint Technologies. "It's kind of like the pot calling the kettle black."

Antitrust lawyer Glenn Manishin of Duane Morris, a veteran of Microsoft's competition battle with the Department of Justice, said links between Google and Yahoo would be "much more problematic" than a Microsoft-Yahoo merger.

Indeed, Google's near monopoly on Web searches is one reason the company should secretly favor a Microsoft-Yahoo merger, experts said. That deal would deflect regulatory attention away from its own market dominance.

While the U.S. Federal Trade Commission has approved Google's proposed $3.1 billion acquisition of digital advertising giant DoubleClick, European regulators have not.

If Microsoft's move on Yahoo is so good for Google, why is it pursuing a deal? Because, Cowen and Co.'s Friedland said, a merger is the "least bad alternative" for Microsoft C.E.O. Steve Ballmer.

UBS' Schachter summed it up. "This merger is fraught with risk for both Microsoft and Yahoo," he said. "But what other choice do they have?"

Robert Scoble's statement, "If you put two turkeys together, you don't get an eagle." is simply golden!