Jeremy Warner's Outlook: Microsoft enjoins Yahoo in Google fight

All change as China tilts at Rio Tinto

At a conference I attended three years ago, Bill Gates, the chairman of Microsoft, said that the mistake he had made with "search" was to outsource the technology to someone else, which was never going to give a state-of-the-art experience and had led his company to be insufficiently focused on this developing area of the internet.

However, search was still at an "embryonic" stage and he wasn't yet entirely convinced it was a proper business at all. In any case, there was still plenty of time to catch up and eventually leapfrog the market leader Google.

Three years later and it is now apparent beyond any doubt that search is indeed a proper business, and, far from catching up, Microsoft is today even further behind than it was then. Bringing the technology in-house and devoting countless billions to its development doesn't seem to have helped one jot. Even for the mighty Microsoft, Google's lead seems quite unassailable.

Unless, of course, Microsoft buys Google's nearest rival, Yahoo, and crunches it together with its own MSN search engine to form a more credible alternative. As it now transpires, Steve Ballmer, Microsoft's chief executive, has been talking to Yahoo on and off about just such a merger for more than a year now, yet Yahoo resisted, believing that it could do better by its shareholders by remaining independent.

An utterly shambolic conference call earlier this week in which Yahoo's returning hero, Jerry Yang, failed to convince anyone that he could perform a Steve Jobs-like miracle on his wounded charge, in combination with figures overnight from Google, which though stunning by any measure seemed to suggest that previously stellar rates of growth are beginning to fade, has given Mr Ballmer his chance.

When it came, the Microsoft offer was unsolicited, but equally it has been pitched at such a premium to the bombed-out share price that Mr Yang will find it hard to resist.

Any serious challenge on anti-trust grounds seems unlikely, despite Microsoft's well-chronicled history of abusing its dominant market position in computer operating systems, servers and linked applications. Most users and advertisers are likely to welcome the creation of a credible alternative to Google, which in a sense has become the Microsoft of the internet – too big and too powerful for anyone's good but its own.

As for interlopers, this too looks unlikely. There was talk a while back of Rupert Murdoch's News Corp injected MySpace into Yahoo in return for a big chunk of the equity, but I doubt this would be seen as an attractive alternative to Microsoft's takeover bid by most shareholders, and News Corp is certainly in no position to counterbid outright. Having just bought the Wall Street Journal, Mr Murdoch is already too highly geared to offer cash and is still too unwilling to suffer any dilution of his family shareholding to countenance equity.

There is considerable execution risk involved here for Microsoft, whose record of post-acquisition integration is not exactly brilliant. Indeed, most of Microsoft's acquisitions to date have been about snuffing out potential competitors. This one is rather different, in that it is primarily about gaining the critical mass in search and related advertising markets to start giving Google a run for its money.

Banging together two such different corporate cultures will be fraught with difficulties. Yahoo is also a terrible hotchpotch of disjointed media interests, which is a large part of its present problem. It still looks and feels more like an old-style internet portal, with expensively bought-in content bolted on, than a modern search business with related networking opportunities.

All the same, the verdict at this stage has to be broadly positive. Microsoft used to be satisfied only with being number one in each of the markets it operates in. In search, the limits of its ambition, for the time being at least, seems just to be a more credible number two.

Even so, any complacency on Google's part would be unwise. Yahoo was once the number one and Microsoft is still a mighty formidable machine once it sets its mind to something.

Bill Gates will be leaving Microsoft shortly to devote himself full time to his foundation. The way the wonderful Google boys – Sergey Brin and Larry Page – have trounced him in cyberspace has long rankled. The acquisition of Yahoo ought to give Microsoft something close to the critical mass it needs to start competing head on with Google in search and perhaps even clip the upstart's wings somewhat.

All change as China tilts at Rio Tinto

It was Microsoft that excited all the interest, but of the two giant transactions announced in Western stock markets yesterday there is little doubt to my mind which was the more significant. In almost every respect, the Chinese raid on Rio Tinto was a watershed. As the largest-ever outward investment by China,it marks a turning point which is dramatically symbolic of China's re-emergence as a global superpower.

As ever, the Chinese seem to be sticking to the national characteristic of inscrutability in explaining the purpose of the stake building. Few were taking the explanation given by Xiao Yaqing, president of Chinalco – that this is a long-term strategic investment pursued independently of any state interference – at face value.

The most popular theory was rather that he is being used as a front for the wider Chinese interest in blocking BHP Billiton's separate assault on Rio, which is seen in large parts of the East as essentially monopolistic with potentially quite serious inflationary consequences for commodity prices.

But though I'm sure the Chinese Government is perfectly happy to see Chinalco perform this role, and as a controlling shareholder in Chinalco would certainly have sanctioned the £7bn cost, Mr Xiao probably has to be believed when he insists that this is entirely his own show pursued simply out of the strategic goal of global expansion into the extractive industries. The Chinese have already been hyperactive in Africa in pursuing mining rights.

I doubt Mr Xiao even knows fully himself where his shareholding might take him. At the very least, it buys him a place at the negotiating table, so that, if there is an eventual shakeout of assets, he ought to be able to secure his share. Rio is also surely right to think that the £60 a share he's paid provides a new benchmark. In any case, it amply demonstrates the inadequacy of the existing BHP offer.

Chinalco's holding is obviously an awkward irritant for BHP, but it is not a blocking stake and, if rumours in the City are to believed, BHP was in any case planning to come back with an offer by next Wednesday's Takeover Panel-imposed deadline worth more than the £60 a share Chinalco has paid.

If it does, that's when the real fun and games begin, for Chinalco would surely have to enjoin some high-powered Chinese partners to mount a credible counter proposal.

The main point of Chinese concern about the BHP proposal isn't in bauxite, the feedstock for aluminium, but rather in the duopoly with Brazil it would establish in supplies of iron ore. Baosteel, China's largest steel producer, would on the face of it have a much greater interest in scuppering the BHP proposal than Chinalco.

Yet the Australian government would certainly have something to say about it if the two eventually partner to bid outright for Rio. Natural resources are a very substantial part of the entire Australian economy. It's all very well to have the Chinese as customers, quite another to have them as owners, controlling the price. Unfortunately for the Australians, the seismic shift in economic and political power now being played out in the world may mean they don't have much choice in the matter.

As the Chinese say, we live in interesting times.

j.warner@independent.co.uk

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