Street: Microsoft must think big

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Some analysts give the chance of an eventual Microsoft takeover of Yahoo! Inc. better odds than they do to Sirius Satellite Radio merging with XM Satellite Radio, and the latter deal already has both management teams in agreement over the terms.

While recent talks of the tech giants seem to be off, at least for now, some Wall Street observers believe a merger or alliance could still come about down the line.

Analysts on Friday discussed the prospects of a "YahooSoft" as if it's Microsoft's last best hope of ever competing with Google. Strange, considering Microsoft's massive market cap, oodles of cash and technological know-how. Not to mention its reputation of so dominating every business it enters that it routinely draws howls for being a monopoly.

But any way you slice it, Microsoft has yet to mount a serious challenge to Google's Internet search and advertising dominance, so it's likely it will pursue an acquisition of Yahoo! for a price more than the $35 a share offer that was reportedly being discussed.

"Microsoft's efforts to build search query share have largely failed, and the magnitude of scale gains that is required is too large to be achieved organically," Goldman Sachs analyst Anthony Noto said.

Given that neither Microsoft nor Yahoo! has found a way to beat Google, some on the Street joked Friday that a combined firm's name should maybe be "Microhoo?"

Noto has a year-end price target on Yahoo! shares of $34, and he told clients that $35 a share, or $50 billion for Yahoo!, is "not really a premium."

While Wall Street has been busy speculating on which small online advertising firm will be bought next in the wake of Google's intention to buy DoubleClick and Yahoo!'s recent purchase of Right Media, Noto said that Microsoft must think bigger.

"Across advertising, Yahoo! is the only game-changing acquisition for Microsoft," he said. "Ultimately, gaining scale across the user base in both advertisers and consumers is Microsoft's only chance at beginning to close the monetization gap versus Google."

He added that Microsoft might want to consider acquiring eBay instead, though. That's because eBay's base of 5 million sellers, he said, are potential advertisers.

The usual three smaller companies considered takeover bait nowadays are 24/7 Real Media, ValueClick and aQuantive. Shares of all three have been mostly in rally mode, though 24/7 took a 9% hit on Friday after an analyst downgrade.

Deutsche Bank analyst Jeetil Patel said that one hitch is that while a Microsoft-Yahoo! combination makes sense, the software giant isn't known for big acquisitions. Recently, for example, it didn't want to outbid Google for either DoubleClick ($3.1 billion) or YouTube ($1.65 billion).

Susquehanna Financial Group analyst Marianne Wolk, who has been pounding the table about her belief that Microsoft needs some sort of hookup with Yahoo!, predicted that there's a 50% chance of a merger happening and that the per-share price could swell to $42.

"The combination of Microsoft-Yahoo! would create a behemoth in branded advertising online," she said.

She said branded advertising represented 52% of the online advertising market last year, and Yahoo! and Microsoft together captured 18% of that, or $2.9 billion, with AOL at 5% and Google next to zero.

Yahoo! CEO Terry Semel might also be feeling the need to do something dramatic to shore up his reputation. Although Yahoo! flourished under his earlier leadership, on Thursday, a day before the stock popped 10% on merger speculation, it had been trading at about the same price it was at two years ago, while Google shares have risen fivefold.
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