Microsoft News Tracker

The long running soap opera of Microsoft’s attempted acquisition of Yahoo ended after a week of hectic negotiations yesterday as Steve Ballmer withdrew the offer. The fundamental reason was a disagreement on price (Microsoft’s last bid was $33 per share and the lowest Yahoo would go was $37), but Yahoo’s threat of a search ad outsourcing deal with Google proved so much of a poison pill that Microsoft did not care to pursue a hostile takeover.

The two protagonists now get to lick their wounds and pursue their own separate paths to online riches. It’s in the nature of the US legal system that Yahoo’s management and board of directors will be sued for not taking the cash when they could, but worse is the very public acknowledgement of the fundamental weakness of Yahoo’s search ad business. As for Microsoft, despite the happy talk that a Yahoo acquisition would merely have sped up Microsoft’s inevitable success in the online business, the Microsoft employees concerned know that they barely escaped a "synergy" bloodbath which is hardly a vote of confidence. Moreover, if Yahoo’s prospects don’t improve, this may turn out to be merely a merger delayed.

Shareholders were justifiably nervous after the first good news called out in the 3Q08 Microsoft earnings report was that the nearly profitless sinkhole of Entertainment and Devices grew revenues by 68%. That such a diversion was necessary was because the milk yields of Microsoft’s leading cash cows, Windows and Office, dropped in a still mostly unexplained manner.

Below are the segment breakouts with some brief commentary based on the 10-Q.

Client:

The big hit here is the $1.14 billion of deferred revenue that got tacked on in 3Q07, but even removing that, revenues were down over last year despite OEM sales (which account for 80% of unit sales) being up 5% and the "premium mix" being up as well. Estimated PC sales growth was 8-9% and theories ranging from piracy to Apple/Linux competition to Microsoft shifting revenue to next quarter have been offered for the shortfall.

Business (mostly Office):

Subtracting the $500M deferred revenue booked in 3Q07 makes this look much better apparently due to strong Office revenue growth from businesses, but consumer revenue was actually down. R&D expenses were up 19% driven by headcount expenses and headcount itself was up 7%, presumably not to add bells and whistles to the traditional Office product.

Server and Tools:

Another sterling quarter for Server and Tools who launched major new products.

Entertainment and Devices (mostly Xbox):

The good news is that E&D made money in 3Q. The bad news is that it didn’t make much, but then it never does. R&D expense was up 26% and sales and marketing expenses were up 29%.

Online Services:

Online advertising revenue grew 39% ($175M) to $619 million including aQuantive’s $47 million. aQuantive also added $97 million in agency revenue. So where did it all go? There was a large write-off from the acquisition of aQuantive plus increases in general expenses for infrastructure, "online content expenses," and headcount. One item that caught my eye was "a $24 million in-process research and development write-off." The Online Services Business (OSB) doesn’t seem to be going anywhere fast. The question, of course, is whether it would go any faster with the addition of Yahoo.

Corporate Level Activity (overhead and legal): 

The big ticket item here was an increase of $1.2 billion in legal expenses including the EU fine.

Bottom Line:

Out of Microsoft’s three cash cows (Windows Client, Office, and Servers) only Servers delivered in accustomed fashion. Entertainment and Devices is all sound and fury signifying nothing, while Online Services is treading water waiting for a Yahoo life preserver

Steve Ballmer’s three week ultimatum to Yahoo’s board of directors to accept the Microsoft acquisition offer passed yesterday with no comment from Yahoo or specific action from Microsoft to carry out the threatened reduction of the offer amount and proxy fight. The next episode in this soap opera is expected early next week and predictions range from Microsoft withdrawing their offer to a full out hammer and tongs proxy battle. The most telling commentary however is likely the desire of Yahoo employees to take the money and Microsoft employees to forget about the whole thing.

Henry Blodget provides a succinct summary of today’s Yahoo quarterly earnings release:

Yahoo has done what it needed to do: report a solid quarter in the high end of the range. The results were not a blow-out and certainly could have been higher. However, they should be enough to allow Yahoo to maintain its current Microsoft stance: no deal unless you raise price. Yahoo has not decided whether to pursue Google outsourcing deal, but clearly still on table.

To make it even more succinct: Nothing’s changed.

Late yesterday, it was revealed that Microsoft has acquired Seattle airfare prediction service Farecast for an estimated $115 million in another apparent technology/personnel buy. So what’s an airfare prediction service? Mark Hendrickson explains at TechCrunch:

Farecast is an airfare pricing comparison tool that also uses a predictive algorithm to recommend when you buy your ticket. So the idea is to show the user not just who has the cheapest ticket, but whether or not waiting might make sense as well. The site has also guarantees tickets at its predicted prices for an extra charge. As of this past fall, it also began helping travelers determine the fairness of hotel pricing.

Microsoft had signed a deal last July for Farecast to provide their service on MSN Travel so presumably there’s a track record to justify the acquisition price.

Update: A commenter at John Cook’s Venture Blog (first link above) makes an important point:

Also, since Yahoo owns FareChase (about the same size as FareCast) and MSN will almost certainly end up with Yahoo, why do they need two travel meta-search sites. Seems like a waste of $115M for MSFT.

Without trying to compare the FareChase and Farecast technologies, there’s a fine line as to what you do or don’t do pending an acquisition that may never be realized, but it does seem that this one could have been delayed a while.