Does Microsoft really need Yahoo? Pondering the opportunity costs

The gloves are clearly off in the Microsoft-Yahoo hostile takeover saga. Microsoft threatens a proxy war.

The gloves are clearly off in the Microsoft-Yahoo hostile takeover saga. Microsoft threatens a proxy war. Yahoo beefs up severance costs and creates an estimated $500 million in additional expenses for Microsoft if the software giant acquires the portal.

But in a research note today, RBC Capital Market analyst Robert Breza raised an interesting question: Does Microsoft really need Yahoo?

The answer thus far has been a resounding yes. Microsoft by its big premium of $31 a share, or $44.6 billion, its willingness to take on some debt and talk of how it needs to close the Google gap almost sounds desperate. And for now I'm on the Microsoft needs Yahoo bandwagon too--even though the deal is likely to be a disaster and proxy talk and board maneuvers can get messy (see Techmeme).

Perhaps that conventional wisdom needs to be challenged. Breza makes the following point: To Microsoft Yahoo is "less of a need than a want." Then analyst then makes the argument that Microsoft could close the Google gap without Yahoo, but at a slower pace.

Currently, Microsoft doesn't have the scale in their search advertising platform, and this lack of scale has slowed them from making the "killer app" that combines one platform for users to target search, display, in-game, mobile, voice, and video marketing. These are all previous investments that depend on SCALE to make any further platform integrations reasonable. Online advertisers are ingrained in Google and Yahoo! platforms. Getting advertisers to spend on the additional overhead for a platform that is a distant third place in terms of search is a difficult task (it's been difficult for Yahoo which is a distant second).

It's possible to argue that without YHOO and a blank check for $45B, Microsoft could make investments that would bring scale over time, and also more synergies beyond just advertising. Salesforce.com at 100% premium is $12B, Omniture at 100% premium is $3B; and that leaves $30B to acquire Facebook. It could be argued that adapting/integrating these platforms with adCenter would bring advertisers/scale to the markets these businesses already serve (business and gen-x-y-z).

Frankly the light bulb went on for me as soon as Breza brought Salesforce and Omniture into the equation. Wouldn't Salesforce.com be a better fit with Microsoft's core businesses? Wouldn't Omniture look swell in a business intelligence or advertising dashboard? Wouldn't those purchase make a lot more sense for Microsoft? I'm not entirely sold on Microsoft buying Facebook, but you get the general idea--the software giant could do more with its money without buying Yahoo.

The thing missing in the discussion about Microsoft's purchase of Yahoo is the simple concept of opportunity costs. What opportunities will Microsoft forgo as it tries to integrate Yahoo? Could Microsoft spend its billions on other acquisitions that make more sense?

It's something to ponder for sure. If Microsoft comes around on this line of thinking Yahoo's board may get its wish and remain independent--much to the chagrin of the portal's shareholders.

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