Microsoft has launched an audacious $44.6bn (£22.4bn) bid for internet rival Yahoo in a deal designed to create an online advertising powerhouse to rival market leader Google.
Microsoft, which came late to the internet advertising market, is offering Yahoo shareholders $31 a share in a combination of cash and its own stock. The deal would rank as one of the largest dotcom takeovers since AOL and Time Warner merged at the height of the tech stock boom.
The news boosted shares in London, sending the FTSE 100 back through the 6,000 level. On Wall Street this afternoon, shares in Yahoo surged almost 50%, to $28.26, while Microsoft fell 5% to $30.94. Google tumbled 9% to $512.90 as analysts anticipated the potential impact of a Microsoft-Yahoo tie-up on its business.
There has been intense speculation about the two giants getting together with Yahoo rebuffing an offer from Microsoft just last year. Microsoft's chief executive, Steve Ballmer, said today that he called his counterpart at Yahoo, Jerry Yang, on Thursday night before going public with the offer.
"Our companies really do share a vision for the potential of online services and advertising specifically," Ballmer said on a conference call with analysts this afternoon. "When you combine the strengths of our two companies the result will be an incredibly efficient and competitive offering for consumers, for advertisers and for publishers.
"A year ago the Yahoo management team told us it was not really the right time to discuss an acquisition, we believed then in the benefits of combining the two companies and we believe now in those benefits more than ever."
In a statement, Yahoo said it had received the unsolicited proposal and its board "will evaluate this proposal carefully and promptly in the context of Yahoo's strategic plans and pursue the best course of action to maximize long-term value for shareholders".
Yahoo's position has certainly weakened over the past year as repeated delays to the roll-out of its new advertising platform Panama have sent its shares into freefall. Earlier this week Yahoo shares fell to a four-year low as Yang, who replaced long-serving chief executive Terry Semel last summer, announced plans to axe 1,000 jobs following a 24% drop in fourth-quarter profits to $205m.
But while Yahoo has suffered, Google has powered ahead in the online search market - which it comprehensively dominates with a global share estimated at 75% - and made moves into the wider online advertising market.
Microsoft reckons the global online advertising market will grow from over $40bn last year to nearly $80bn by 2010 and as the market grows, advertising platforms must consolidate to get the benefits of scale. Yahoo, for instance, was once the undisputed market leader in online search, but now controls just 17.7% of the US search market compared with Google's 56.3%.
Microsoft believes that putting together Yahoo's search and online advertising technology with its own onto one central platform will create a much more powerful competitor to Google.
"Today the market is increasingly dominated by one player," said Kevin Johnson, president of the platforms and services division of Microsoft. "By combining the assets of Microsoft and Yahoo we can offer a more competitive choice for consumers, advertisers and publishers. The fact is the industry will be better served by having a more credible alternative in the areas of search and advertising."
Ballmer admitted that Microsoft could have continued building its existing business on its own but the deal will be "an accelerant to progress" in catching up with market leader Google.
"Sure we could have hired engineers and kept hiring engineers and we are very good at that," he said. "But at the same time the market continues to grow and the leader continues to consolidate its position."
On analysts' call, Microsoft's executives went out of their way to praise Yahoo's contribution to the growth of the internet. "Since its early years Yahoo has played a key role in the growth and evolution of the web," said Microsoft's chief software architect Ray Ozzie. "We have tremendous respect for the engineering team and the work they have done, they have been pioneers and leaders in building compelling high-scale services and infrastructure."
But the firm's takeover approach will be seen by many in the internet industry as extremely opportunistic. While $31 a share is a 62% premium to Yahoo's current stock price, the shares have plunged in recent months from a 52-week high of just over $34 in October.
Microsoft reckons it can cut costs across the combined business, leading to savings of at least $1bn a year. It reckons the deal, which it would like to close in the second half of this year, will have a small beneficial effect on its own financial results by the second full year of ownership.
While it has tinkered with its long awaited Panama platform, Yahoo has missed out on several high-profile internet advertising deals. Google snapped up MySpace's traffic while Microsoft saw off Yahoo and Google and signed an advertising deal with Facebook which also saw the Redmond-based company take a small stake in the company. A year ago, Yahoo had made a tentative offer for the social networking site.
If any deal is agreed it is likely to be heavily scrutinised by regulators on both sides of the Atlantic. As well as their positions in the online search market both companies are major players in the wider online advertising market and have recently made moves to buy ad-serving companies, which place adverts on websites and are seen as playing a crucial role in the future development of online advertising.
Last year Google snapped up ad-server Doubleclick while Microsoft bought aQuantive, Yahoo bought RightMedia and WPP snapped up 24/7 Real Media.
Analysts were split over the merits of the deal. One called the 62% premium "exorbitant", but others suggested it could help the markets shrug off the recent financial turmoil.
Internet advertising executives, meanwhile, welcomed the possibility of a stronger competitor to Google. "A Yahoo acquisition by Microsoft will improve competition in the European search market, which is overwhelmingly dominated by Google which has over 80% of the market in UK, France and Germany," said Andrew Walmsley, co-founder of London-based digital media agency i-level.