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Microsoft's midlife strife

From Saturday's Globe and Mail

Forget the Internet. Forget Facebook and MySpace, the iPhone, Steve Jobs and the preposterous Apple cult. There's one reason, and really only one, that Microsoft wants to spend nearly $45-billion (U.S.) to buy Yahoo.

It's because midlife stinks.

Midlife is the time when you look in the mirror and realize the promise of youth is gone; that you'll never be quite as healthy, or as fit, or as good-looking, or as cool or as carefree as you once were. Corporate midlife is similar: It's the moment when the hyperkinetic growth of adolescence is over, and nothing is quite as exciting or as easy as it was before.

For the founders and executives of fallen growth companies, this change is dismaying.

Wall Street no longer fawns over them. Their stock price falls, as does their prestige, and they find themselves in the humbling position of scuffling to catch up to the faster, shrewder new kid – in this case, that's Google.

Microsoft has been going through this awkward transition for several years. Yahoo, the dethroned king of the Web, is immersed in it – in the middle of a middle-life crisis, you might say.

The unsolicited takeover bid from Microsoft, America's third-most valuable company at $293-billion, comes after a long and fruitless courtship of Yahoo. In late 2006 and early 2007, the two companies held wide-ranging talks on a business partnership or merger, but they went nowhere. Yahoo's board rejected the takeover idea as premature.

Since then, two things have happened. Google's financial results were very strong, proving that its dominance of the Internet search business is growing, not receding. The U.S. economy has also turned south, pulling the outlook for advertising – and Yahoo's prospects – down with it. On Wednesday, Yahoo's stock price hit its lowest point since 2003, having fallen 45 per cent in three months.

Microsoft's bid is, to say the least, opportunistic. Had chief executive officer Steve Ballmer tried to buy Yahoo last autumn, he would have to had to offer at least $60-billion – and even then he might not have been taken seriously.

But even though Yahoo is struggling, it represents a possible solution to a vexing problem for Microsoft. It may be one of the most successful companies in the history of capitalism, earning $14.1-billion in fiscal 2007, but the bulk of its profit still comes from its old products, primarily the Windows operating system. It has never managed to crack the market for online ads in a big way. Microsoft's answer to Google, the MSN portal, is an also-ran; the company's online services division lost $732-million last year on just $2.5-billion in revenue.

Mr. Ballmer knows that, for all of the unfavourable comparisons to Google, the business he's trying to buy is a healthy one. Here's what midlife looks like for Yahoo: Last year its revenues grew 8 per cent, to $7-billion; it made a $700-million operating profit and generated enough cash flow to buy a small island nation in the South Pacific. The core business, online advertising revenue, is not in such terrible shape. Some Web experts will tell you that Yahoo's improved search engine is now superior to Google's.

Yahoo also produces original content, employing some stellar writers and columnists, which ought to provide at least a small advantage over Google's model of stealing (pardon me, “aggregating”) the work of others. And, like a lot of senior tech companies (Microsoft included), Yahoo keeps its balance sheet as though it's preparing for the next Great Depression. It has $2-billion in cash and short-term investments versus $750-million in debt. Yahoo is not exactly a distress case.

So what ails it? The same things that have dogged Microsoft since it entered its middle years: Lack of focus, lack of drive, spoiled by earlier success, too fat. This isn't merely what outsiders think; read the now-famous “Peanut Butter manifesto” written in late 2006 by Brad Garlinghouse, a Yahoo senior vice-president. “We have lost our passion to win. Far too many employees are ‘phoning' it in …Where is the accountability?” Peanut butter was his metaphor for a company spread too thin.

His recommendation was to chop business units and let go of 15 to 20 per cent of the staff. His bosses read the memo, then ignored it, adding 2,200 full-time employees in the first nine months of this year.

What Yahoo suffers from, in addition to complacency, is the curse of being second-best. It's somewhat analogous to Unilever or Bank of Montreal or Zellers: They may be fine businesses, but they're not Procter & Gamble or Royal Bank or Wal-Mart.

In technology, the No. 2 spot is particularly uncomfortable. Technology takes time for consumers to learn; for that and other reasons, it tends to create a single dominant player in any field. “Once it's settled down, Google's got it locked up, and no matter what Microsoft or Yahoo do, they can jockey around their position, but their market shares haven't changed,” Bill Miller, the famous U.S. investor, told The Globe and Mail in a recent interview. (He should know – his fund is a major shareholder in both Yahoo and Google.) That doesn't mean that Yahoo is in decline, or that it won't be a fine investment for Microsoft, should its bid be a winner. It's just that when they reach midlife, companies, like people, learn that they must make compromises. In their mutual midlife crisis, Microsoft and Yahoo may discover they're better off entering their golden years together than apart.

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