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Sometimes rumors sound crazy.  Sometimes they’re so crazy, they end up becoming true.  Microsoft proved that early this morning with the surprise announcement of an unsolicited cash and stock takeover offer for struggling web giant, Yahoo.

Rumored at times to be possible, probably, and impossible, one thing a deal between the two never seemed was real. For more than eighteen months of chatter, partnership talk and innuendo, this prospect seemed like somebody’s fantasy.  Now it is shockingly real.

Microsoft has offered to pay $31 a share, which represents a purchase price of approximately $44.6 billion. The proposal would provide for cash and stock payment. Yahoo! shareholders will be able to choose either cash or stock, with the total deal being half of each. The offer represents a 62 percent premium above the closing price of Yahoo! stock on Jan. 31, 2008.

62% to current trading prices is a substantial premium, but a key question is whether Yahoo’s board and shareholders will believe there is greater long term value in independence?   Given the economic climate, and recent earnings announcements, that question will likely be heavily debated.  The company is in the midst of a prolonged corporate turnaround, and has been simultaneously penalized for under performance by an uneasy market.  Consequently The stock price is low, perhaps too low, for even a 62% premium to seem like a windfall.  We’ll have to wait and see.

One thing is certain: whether this deal happens or not, it’s about the future of advertising.  In July. shortly after their $6b purchase of ad firm aQuantive cleared antitrust review, CEO Steve Ballmer told financial analysts “[Microsoft is] hell-bent and determined to allocate the talent, the resources, the money, the innovation to absolutely become a powerhouse in the ad business.”  In October, Ballmer reiterated that pledge and went so far as to predict 25% of Microsoft’s business would come from advertising in just a few years.  

Microsoft says the online ad market is worth as much as $40b today and widely expected to double by 2010.  Worth more than that is the larger advertising opportunity:  including broadcast and print markets that may migrate to digital platforms, the greater ad market represents a more than $600b global marketplace.

Microsoft won’t sit idle in their effort to stake a claim for that gold, or watch as Google tries to grab it from Madison Avenue’s weakening grasp. 

In December, Microsoft wooed Viacom into a five year ad deal that secured long term ad inventory at a number of high traffic web properties.  The exclusivity of the deal also locked out rival Google.  Microsoft scored a similar coup signing up CNBC  and outbidding Google to acquire the ad rights on social network Facebook and social news aggregator, Digg.

Adding Yahoo would be a crown on Microsoft’s ad strategy and would fast-track Ballmer’s 25% revenue prediction.  It would create a company with combined annual revenue of well beyond $60b.  It would also boost Microsoft’s sub 10% search marketshare to a number above 30%..

In his letter to Yahoo’s board, Ballmer made his case saying:

“While online advertising growth continues, there are significant benefits of scale in advertising platform economics, in capital costs for search index build-out, and in research and development, making this a time of industry consolidation and convergence. Today, the market is increasingly dominated by one player who is consolidating its dominance through acquisition. Together, Microsoft and Yahoo! can offer a credible alternative for consumers, advertisers, and publishers”

(The dominant unnamed player is, clearly, Google)

If Yahoo accepts, which amounts to a big “what if” at this point, the deal will surely face heavy regulatory scrutiny, both under U.S. Anti Trust law (Hart Scott Rodino, etc) and in the EU.   In Microsoft’s proposal letter they stated confidence such approval would not be a problem and a deal could close in the second half of 2008.   That view may be overconfident.  The Google/DoubleClick advertising deal was put under microscope.  The combination of advertising and content that would come from a joined Yahoo and Microsoft is certain to get even closer examination.

Deeper analysis and more news on the proposed merger will be provided on Metue as the story unfolds.

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