Yahoo will ride into the sunset after getting acquired by Microsoft

Microsoft Corporation (NASDAQ: MSFT), the giant, the goliath, the conqueror, roared loud today. The roar was so LOUD that the effects of it were felt worldwide across all time zones, across all geographies. Out here, the roar provided a huge jolt to the Wall Street in the morning at 6:30 am, and then reverberated through out the entire day. No trip to Starbucks today! Strangely enough, the roar did not come in the form of a speech by Steve Ballmer or Bill Gates mightily touting the success of Windows Vista, it came instead in the form of a written plea, a note in the form of a press release that went out to the board, employees, and shareholders of a rival, a sort of a friendly takeover, almost a pat on the back, urging them to consider Microsoft's request to acquire them at 62% premium to the closing stock price. Kudos Microsoft! You have not only mastered the art of creating and preserving market leadership, now you have shown us how to acquire a large company and get the world behind you. Now, it's up to the board to decide.

Microsoft is one of the Top 20 Innovators of The Innovation Index. The Innovation Index closed 2007 with 66% gain, crushing the major U.S. indices.

Microsoft was in a friendly mood today, touting how great their rival is, perhaps even patronizing it. For the rival is no other than Yahoo, the company that got the Internet going, and is symbolic of the freedom and free spirit that embodies the Internet. Yahoo Inc. (NASDAQ: YHOO) was one of the Top 20 Innovators of The Innovation Index for 2007.

"We have great respect for Yahoo!, and together we can offer an increasingly exciting set of solutions for consumers, publishers and advertisers while becoming better positioned to compete in the online services market," said Steve Ballmer, chief executive officer of Microsoft. "We believe our combination will deliver superior value to our respective shareholders and better choice and innovation to our customers and industry partners."

"Our lives, our businesses, and even our society have been progressively transformed by the Web, and Yahoo! has played a pioneering role by building compelling, high-scale services and infrastructure," said Ray Ozzie, chief software architect at Microsoft. "The combination of these two great teams would enable us to jointly deliver a broad range of new experiences to our customers that neither of us would have achieved on our own."

The online advertising market is growing at a very fast pace, from over $40 billion in 2007 to nearly $80 billion by 2010. The resulting benefits of scale along with the associated capital costs for advertising platform providers make this a time of industry consolidation and convergence. Today this market is increasingly dominated by one player. Together, Microsoft and Yahoo! can offer a competitive choice while better fulfilling the needs of customers and partners.

"The combined assets and strong services focus of these two companies will enable us to achieve scale economics while reaching R&D critical mass to deliver innovation breakthroughs," said Kevin Johnson, president of the Platforms & Services Division of Microsoft. "The industry will be well served by having more than one strong player, offering more value and real choice to advertisers, publishers and consumers."

Is Microsoft playing the role of a savior, or the role of a pirate waiting for the best opportunity? Yahoo just announced the annual and fourth quarter earnings two days ago, and missed the earnings estimates, and saw its stock plummet more than 10%. Further, Yahoo co-founder and chief executive officer, Jerry Yang, said, "While we will continue to face headwinds this year, we believe that the moves we are making will help us exit 2008 stronger and more competitive and return to higher levels of operating cash flow growth in 2009." Yang was essentially telling the world and the investors to give Yahoo until 2009 to rebound, to turnaround. The investors simply balked and retreated. Hence, this provided Microsoft the best opportunity, at a time when the investors were fleeing thereby sending Yahoo stock at a multi-year low, and a shaken leadership who may look for the escape hatch.

In a letter sent to the Yahoo board, Microsoft explains the rationale behind the acquisition: "Microsoft's consistent belief has been that the combination of Microsoft and Yahoo! clearly represents the best way to deliver maximum value to our respective shareholders, as well as create a more efficient and competitive company that would provide greater value and service to our customers. In late 2006 and early 2007, we jointly explored a broad range of ways in which our two companies might work together. These discussions were based on a vision that the online businesses of Microsoft and Yahoo! should be aligned in some way to create a more effective competitor in the online marketplace. We discussed a number of alternatives ranging from commercial partnerships to a merger proposal, which you rejected. While a commercial partnership may have made sense at one time, Microsoft believes that the only alternative now is the combination of Microsoft and Yahoo! that we are proposing."

Microsoft articulates this further, "In February 2007, I received a letter from your Chairman indicating the view of the Yahoo! Board that "now is not the right time from the perspective of our shareholders to enter into discussions regarding an acquisition transaction." According to that letter, the principal reason for this view was the Yahoo! Board's confidence in the "potential upside" if management successfully executed on a reformulated strategy based on certain operational initiatives, such as Project Panama, and a significant organizational realignment. A year has gone by, and the competitive situation has not improved."

Make no mistake. Whereas Microsoft is willing to provide a steep premium of 62% and value Yahoo at a huge $44.6 billion, the real prize that Microsoft is going after is Google Inc. (NASDAQ: GOOG), another Top 20 Innovator of The Innovation Index. Microsoft accepts Google's dominance in the market of online search and advertising (it states this in its own press release), and Microsoft does not like it and is not willing to accept it. It has waited way too long, tried many different things with its own MSN and Live services, and yet has not made a dent in the Search market. And the lead has only grown. Google narrowly missed earnings in the latest quarter. Microsoft smells blood. If Microsoft acquires Yahoo, together they would own about 32% of the U.S. search market, still a distant second to Google's 50% plus market share. But, if Microsoft does not acquire Yahoo, and with Yahoo floundering, it may have to give up on the search market altogether. Which Microsoft is not willing to do!

So now the question of the day is "What if Jerry Yang and the Yahoo board reject Microsoft's latest overture?" Are they in a position to defend the rejection this time around? Yahoo shareholders are definitely salivating at the sweet offer, and would be unwilling to relent now. By going public, Microsoft has really put the acquisition in the hands of the investors and shareholders. How did Yahoo reply to Microsoft bid? Yahoo issued a press release indicating: "The Company said that its Board of Directors 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 was quick to point out that shareholders matter.

How would the deal impact Google? Last year, I talked about Google versus Yahoo - A tale of two cities and Google's growing market share; there were even talks on whether Yahoo can catch Google. Google will have a worthy nemesis in the short term, however, may prove to be a bigger winner in this particular battle in the longer term. It is quite possible that after Microsoft acquires Yahoo, even more users will switch from Yahoo and begin using Google services. Yahoo brand still represents a sort of enigma, the last man standing in the heated battle of Internet. Yahoo is the underdog that many users still like to use and embrace. However, with the takeover by Microsoft, this perception will change overnight. And Yahoo users may not stay with Yahoo, and go to Google. This could benefit Google even more. If Microsoft is to create a real market out of the Yahoo brand, it must embrace the Yahoo brand, and relinquish its own search to Yahoo eventually. Perhaps this should be Yahoo board's decision - only merge if Yahoo brand and Yahoo search stays.

Assuming Microsoft finds a way to pay for this large acquisition (Microsoft has proposed 50% cash or about $22 billion, and 50% stock), how would the $44.6 billion deal compare to the Top Ten Mergers and Acquisitions since 2000? It would not make it to the top ten list, however, will definitely make it in the top twenty. And it would be the largest acquisition by Microsoft ever, easily eclipsing last year's $6 billion acquisition of AQuantive.

The largest M&A deals worldwide since 2000:

Rank	Year	Acquirer	Target	Transaction Value (in Mil. USD)
1	2000	Merger: America Online Inc. (AOL)	Time Warner	164,747
2	2000	Glaxo Wellcome Plc.	SmithKline Beecham Plc.	75,961
3	2004	Royal Dutch Petroleum Co.	Shell Transport & Trading Co	74,559
4	2006	AT&T Inc.	BellSouth Corporation	72,671
5	2001	Comcast Corporation	AT&T Broadband & Internet Svcs	72,041
6	2004	Sanofi-Synthelabo SA	Aventis SA	60,243
7	2000	Spin-off: Nortel Networks Corporation		59,974
8	2002	Pfizer Inc.	Pharmacia Corporation	59,515
9	2004	Merger: JP Morgan Chase & Co.	Bank One Corporation	58,761
10	2006	Pending: E.on AG	Endesa SA	56,266

Source: Institute of Mergers, Acquisitions and Alliances Research, Thomson Financial

Bottomline:

Yahoo board will accept Microsoft's proposal this time around. This is one acquisition where Google is not going to try to outbid Microsoft. There will be intense negotiations between Yahoo and Microsoft on the future of Yahoo Search, key Yahoo properties such as email and Finance, and Yahoo employees. However, in the end, this would be too sweet a deal for the Yahoo board to reject. Yahoo will ride into the sunset!

Invest in the Innovation Index Fund

We launched the new Innovation Index Fund in December, 2007 that invests in the Innovation Index and returned 66% in 2007, and 174% in the previous five years. If you want to learn more about the Innovation Index Fund, fill out your contact information at the bottom of this form: http://www.innovationindexgroup.com/invest.html

The Innovation Index Reports:

Invest in The Innovation Index - Invest in the brand new Innovation Index Fund
Introducing The Innovation Index Fund - Invest into The Innovation Index
Top 50 Innovative Companies in the world - 2007 Report on Top 50 Companies
Annual Report - Chapter One - Total Innovation Activity - 2006 Annual Report One
Annual Report - Chapter Two - The Top Innovator - 2006 Annual Report Two
Annual Report - Chapter Three - The Innovation Insights - 2006 Annual Report Insights
Innovation and Stock Performance Correlation - The Innovation Index and Stock Performance

About The Innovation Index

The Innovation Index introduced in December 2006 is a weighted stock price index of the top 20 Innovators in North America.

The Innovation Index returned 66% in 2007, and returned 174% over the previous five years (2002-2006). This assumes equal investment in each stock of The Innovation Index as of December 31, 2001. An average of $100 invested in The Innovation Index on December 31, 2001 returned $454 as of December 31, 2007. By comparison, $100 invested in S & P 500 returned 28% or $129, $100 invested in NASDAQ returned 34% or $136, and $100 invested in the Dow Jones Index returned 30% or $131 through December 31, 2007. The Innovation Index beats the S & P 500, NASDAQ and Dow Jones Index by more than seven times over the past six years.

Alphabetical list of the Top 20 Innovators of The Innovation Index for 2008 and their stock ticker symbols:

3M Company - (NYSE: MMM)
Amazon.com, Inc. - (NASDAQ: AMZN)
America Movil - (NYSE: AMX)
Apple Inc. - (NASDAQ: AAPL)
AT&T Inc. - (NYSE: T)
Best Buy Co., Inc. - (NYSE: BBY)
Cisco Systems, Inc. - (NASDAQ: CSCO)
Costco Wholesale Corporation - (NASDAQ: COST)
eBay Inc. - (NASDAQ: EBAY)
General Electric Co. - (NYSE: GE)
Google Inc. - (NASDAQ: GOOG)
Hewlett-Packard Co. - (NYSE: HPQ)
Intel Corporation - (NYSE: INTC)
International Business Machines Corp. - (NYSE: IBM)
Merck & Co., Inc. - (NYSE: MRK)
McDonald's Corporation (NYSE: MCD)
Microsoft Corporation - (NASDAQ: MSFT)
NIKE, Inc. - (NYSE: NKE)
Research In Motion Limited - (NASDAQ: RIMM)
The Proctor & Gamble Company - (NYSE: PG)

The Innovation Index will analyze the positions and standings of the Top 20 Innovators at the end of each year. For 2008, there will be no further changes in The Innovation Index.

Disclaimer: The Innovation Index Group, Inc. invests in the stocks comprising The Innovation Index.