Why Google/YouTube Was Embraced and Microsoft/Yahoo Is Hated

By Howard Lindzon
Globe Investor Magazine Online, February 14, 2008

Howard Lindzon is a Canadian portfolio manager at Lindzon Capital Partners in Phoenix, Ariz. He also is a partner at Toronto-based venture capital fund Knight's Bridge Capital Partners and was the founder of wallstrip.com, a video website about momentum stocks.

It's a crummy time to be positive. It's a crummy time to be a momentum investor.

The market could care less about me and my style though. It opens every day at 9:30 eastern regardless. Technology stocks were playing second fiddle to the credit crisis in news, until Microsoft's gigantic $44- billion (U.S.) hostile, and now rejected, bid for Yahoo came along. At least that got me interested again.

I hated this deal from the minute it began and the price action says that the huge institutions agree. Since the announcement, the market has spoken. Microsoft is down more than 20 per cent.

Here's my take on why the deal will never be good for shareholders.

It starts with this quote I got over at Seth Godin's blog which sums up the technology business. You need to remember this when making technology investments in the stock market: "Encyclopedia salesmen hate Wikipedia, and CNET hates Google. Newspapers hate Craigslist and music labels hate Napster. Used bookstores hate Amazon, and so do independent bookstores. Dating services hate Plenty of Fish and of course, the local shoe stores hates Zappos.com. And courier services hate fax machines and monks hate Guttenberg. Apparently, technology doesn't care who you hate."

Or in other words, a disruptive technology is going to win no matter how much the old business hates it. In this case, Google is the disruptive technology and Microsoft is the old business and no one cares whether Microsoft (Steve Ballmer) hates Google.

The deal is doomed because Google is a web-native company, while Microsoft is not. Let me explain further. Microsoft, as well as Yahoo, rely on centralized control models, rather than distributed network models (web native). Thus, Microsoft and Yahoo are not aligned with the grain of the web, which at its heart is a fundamentally distributed network.

When Microsoft and Yahoo are both lacking the same quality, merging won't help their cause. Both Microsoft and Yahoo rely on software licence lock-ins (Windows, Office, IM clients, and webmail) to maintain their revenues - but without distributing any of that value to the network or harnessing the value that the network could give back if they did.

As such, they do not benefit from network effects, which is precisely what powers Google - thus, why Google will likely still beat a combined Microsoft/Yahoo.

Google creates massive leverage at every level. Google has the power of the web. It's in their DNA. They have no packaging, shipping, production or marketing costs. The more people use Google, the more and more powerful it gets and the more value it has. Microsoft had a software monopoly and operating leverage but that is fading. They are a media company and trying to buy Yahoo (a web media conglomerate) only makes it more clear.

In Google's eyes they are not even competing.

The market does not always get things priced right, especially in the short term. But I believe it has the Microsoft/Yahoo deal priced right. More time will be needed on Google/YouTube as to whether that deal was a smart one. But more than one year later, Google is much higher than it was pre-YouTube . Furthermore, YouTube continues to dominate web video.

It's a web-native juggernaut as well.

(Disclosure: I'm long Google.)

Special to The Globe and Mail