Microsoft-Yahoo better as partners, not one

SAN FRANCISCO/LOS ANGELES, May 5 (Reuters) Were Microsoft Corp. and Yahoo Inc. to merge, they would face a Noah's Ark problem: they've got two of everything.

As the biggest Internet players behind Google Inc. , Microsoft and Yahoo's overlapping Internet businesses range from instant messaging to e-mail and advertising, as well as dozens of similar media and e-commerce properties, including news, sports, travel, music and finance.

Analysts and investors say that a strategic partnership, perhaps leading to an eventual combination, makes greater sense than an outright merger between the two, given the high amount of overlap between the companies' services.

Reports on Friday that the on-again, off-again talks were on again revived a long-simmering debate over how best Microsoft and Yahoo can fight Google.

A source close to the situation said later in the day that talks had cooled.

''This is a situation where one and one equal less than two'' because the consolidation process would result in fewer users overall, said Matt Rosoff, an analyst with research firm Directions on Microsoft.

''Some of those services would be consolidated,'' he said.

Even combined, Microsoft and Yahoo would present only a weak challenge to Google's dominance of the Web search market, said Trip Chowdhry, an analyst with Global Equities Research.

Together, Microsoft and Yahoo would have 38 percent of the U.S. Web search market, versus Google's 48 percent.

But they would have only 27 percent worldwide, compared with Google's 66 percent, according to traffic data from audience measurement firm comScore Inc.

BIG JOB CUTS LIKELY ''An all-out merger may be difficult. I am sensing that there may be a very tight strategic alliance instead,'' said Chowdhry, who tracks Microsoft and Google, but Yahoo only indirectly, as competitors of the first two companies.

Chowdhry thinks a partnership combining Microsoft's strength in technology and Yahoo's audience of 500 million monthly users could help the companies attack Google on dozens of fronts, beyond Web search, where Google is weaker, such as e-mail.

A combination could create new forms of competition for Google, UBS analyst Ben Schacter wrote in a research note.

Microsoft and Yahoo are the two biggest consumer e-mail providers, with 19 percent of total minutes spent by U.S. Web users, compared with just 3 percent for Google, he said.

And Microsoft would gain control of Yahoo's Web search service, which is No. 2 behind Google and Yahoo's recently upgraded Web search advertising system, dubbed Panama, Global Crown Capital analyst Martin Pyykkonen said.

But a combination also could lead to up to 50 percent of Yahoo's employees being let go, said Pyykkonen, who rates Yahoo shares ''overweight.'' Chowdhry said 30 to 50 percent of employees of Yahoo and Microsoft's Internet business could be cut.

In a full-scale merger, there also would be the big threat of a brain drain among Yahoo employees steeped in Silicon Valley's age-old Microsoft-hating culture.

A hot job market, especially among the latest generation of ''Web 2.0'' startups, means that many Yahooligans could find new jobs quickly, Pyykkonen said.

Chowdhry identified a fundamental technology conflict that would undermine any quick shot at merging Microsoft and Yahoo.

Yahoo's underlying software largely runs on Java code, while everything at Microsoft runs on its own .Net coding.

''Merging the technology and services is not a snap deal,'' he said. ''It will be a slow process of shutting down (overlapping) services.'' Microsoft's willingness to buy Yahoo struck at least one major holder of Microsoft shares as ''an act of desperation.'' ''If a deal gets done, it might be a red flag that (Microsoft is) not seeing the growth doing it organically,'' said Todd Lowenstein, a money manager with HighMark Capital Management, which has about 3 percent of its $1.5 billion in assets invested in Microsoft.

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