Microsoft looking to buy into Yahoo?

Microsoft's share price has taken a beating lately, in part because of the company's increased spending on R&D. Microsoft may be preparing to write a much larger check, as the Wall Street Journal is reporting (subscription required) that the company and super-size Internet portal Yahoo! have been in talks over Microsoft's possibly purchasing an equity stake in the portal.

Here's the rationale.

Despite Microsoft's efforts over the past couple of years and a promising Windows Live beta, the company is still arguably far behind Google in search, advertising, and web services. In the meantime, Google is making moves that could be interpreted as positioning it to encroach on Microsoft's turf, such as buying Writely and launching the Google Page Creator. In addition, MSN/Windows Live is a distant third in search engine usage, according to Search Engine Watch.

Yahoo has a very strong portal presence and has made some smart acquisitions over the past couple of years, including Flickr and del.icio.us. Arguably, it is also the most popular web site in the US, with over 100 million unique visitors per month, according to the Journal.

Where Yahoo is lagging is the all-important search, to the point that despite its strong second place, the company made noises about giving up on passing Google. Those comments didn't sit well with the search team at Yahoo, which quickly rebutted the CFO's throw-in-the-towel comments. That said, Yahoo still trails Google by a wide margin when it comes to search, 42.7 percent to 28.0 percent (MSN comes in at 13.2 percent) for the month of March.

Over the past year, there have been senior-level talks between Microsoft and Yahoo over some sort of partnership, with the most likely scenario being the software maker buying an equity stake in the portal. This would be a big change for Microsoft, given its traditional reluctance to make big acquisitions. Ballmer & Company did make a play for a stake in AOL, briefly emerging as the front-runner before Google pulled the trigger on a 5 percent stake near the end of 2005. Much less likely is Microsoft selling off MSN to Yahoo.

Currently, there do not appear to be any active discussions between Microsoft and Yahoo. That doesn't rule out the possibility of a deal. The two parties may very well return to the negotiating table at some point if the principals at Microsoft and Yahoo think they can make a deal, or if the senior leadership in Redmond thinks its MSN/Windows Live group ultimately isn't up to the task of dethroning Google. It's even possible that Microsoft could make a play to acquire Yahoo outright, but that could do nasty things to its solid balance sheet depending on how such a deal was structured. Whatever route Microsoft and Yahoo take, one thing is for sure: all roads to online supremacy go through Mountain View, California.

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