03/28/2008 02:48 am ET | Updated May 25, 2011

Microsoft's Brilliant Bid for Yahoo!

Microsoft took a page out of Rupert Murdoch's book and made an offer for Yahoo that Yahoo can't refuse.

The $31 a share bid represents a 62% premium over the stock's closing price and will look like manna from heaven to Yahoo's beleaguered shareholders. Yahoo CEO and Founder Jerry Yang and the rest of the Yahoo board won't want to sell the company, but they'll have no choice. A refusal to engage with Microsoft and hammer out a deal would likely result in a shareholder rebellion.

For several reasons, the deal makes great sense strategically:

  • There are now 4 big global Internet players—Google, Yahoo, Microsoft, and AOL—and the market will only support three (at most).
  • Yahoo and Microsoft will be far more competitive with Google if they combine forces.
  • This is a scale business: Combining the two companies will save at least $1 billion on research and development, marketing, administrative, and other costs.
  • The combined company will be a "must-buy" for advertisers, which should improve the company's revenue growth rate.

I expect Yahoo will briefly consider its alternatives and probably make a couple of exploratory calls to other potential bidders, including Google and AT&T. I don't think either will emerge as serious contenders (and the traditional media companies just plain can't afford Yahoo).

I do not think Google will bid because doing so would only further antagonize regulators and customers who already think the company is too powerful. A source within Microsoft, meanwhile, tells me that AT&T encouraged Microsoft to make this bid and has no interest in going after Yahoo itself.

After "considering" the offer, therefore, I suspect Yahoo will conclude that it has no choice but to accept. Yahoo's management may try to get Microsoft to increase its offer, but unless they can first persuade Yahoo shareholders that remaining a stand-alone company is a better idea (a tough sell right now), they won't have much negotiating leverage.

The biggest risk to the deal will come after it closes. Microsoft will have to work hard to give Yahoo the freedom to compete with Google, some of which will involve competing with core Microsoft products. Microsoft will also have to find ways to retain Yahoo's key talent, who may not want to work inside a sprawling global behemoth. Microsoft appears aware of these challenges, however, and is talking a good game about how it plans to deal with them.

The bottom line: A brilliant move on Microsoft's part and the deal should quickly go through.

For more details, please see our full coverage on Silicon Alley Insider.

Disclosure: I have long-term positions in both Yahoo and Microsoft.