Microsoft offers $45bn for Yahoo as it tries to close the gap on Google

Microsoft believed last night that it had snookered Yahoo into agreeing a $44.6bn (£22.7bn) takeover, after 18 months of having its bid overtures rebuffed by the ailing internet giant.

Steve Ballmer, Microsoft's chief executive, dramatically went public with his hostile offer yesterday, promising to combine two of the internet's most powerful brands in an alliance against the market-dominating Google.

The bid – half in cash, half in Microsoft shares – was pitched at a 62 per cent premium to the Yahoo share price on Thursday night, and timed to capitalise on growing disillusionment with the company's strategy after another Yahoo profit warning this week. At the same time, Microsoft's advisers were privately hinting that if Yahoo's board members voted against the deal, they could face an attempt to oust them at the company's shareholder meeting in the summer.

Coming after six months where merger and acquisition activity had all but dried up, the prospect of such a giant deal energised the stock market and shone a spotlight on the tech sector in particular. "This is the biggest deal since AOL and Time Warner merged in 2000," said Peter Rowell, chairman of technology M&A adviser Regent Associates. "Mergers and acquisitions will continue to be a fundamental part of the technology industry in 2008, barring a severe recession."

Mr Ballmer argued that combining Microsoft's loss-making MSN internet business with Yahoo would enable the pair to make more money from online advertising than they have been able to do as separate businesses, because it would be selling space on a much bigger portfolio of MSN, Yahoo and partner websites. A deal would also generate $1bn of annual savings, while still allowing investment in new technology for better tailoring ads to internet users' preferences.

"Today, the market is increasingly dominated by one player who is consolidating its dominance through acquisition," Mr Ballmer wrote to Yahoo founder and chief executive Jerry Yang, in a letter made public yesterday. "Together, Microsoft and Yahoo can offer a credible alternative for consumers, advertisers and publishers."

Yahoo claims that almost half a billion people regularly interact with its network of internet sites, which include news, finance and entertainment content, soc-ial networking, including the Flickr photo-sharing service, and email and messaging services. MSN's internet offering is smaller but overlapping, and both companies also run search engines that have been crushed by the Google juggernaut since the start of this decade.

Mr Ballmer's letter revealed that Microsoft and Yahoo held talks about a tie-up in late 2006 and early 2007, but Yahoo pulled out. In February last year, Yahoo told Microsoft that it believed its go-it-alone strategy, including the roll-out of a new advertising technology, would boost the company. "A year has gone by and the competitive situation has not improved," Mr Ballmer chided, before ending on a threat: "Depending on the nature of your response, Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo's shareholders are provided with the opportunity to realise the value inherent in our proposal."

Yahoo stock rose almost 48 per cent in New York. In a terse statement, Yahoo promised it would evaluate the offer and respond in a timely manner.

Under its poison pill laws, Yahoo could issue new shares to prevent a hostile bidder buying more than 15 per cent of the company without the board's say-so, but Micro-soft advisers have already examined the possibility of offering a slate of new board members at the annual meeting in a proxy fight that would double as a shareholder vote on the bid. Microsoft would have until mid-March to launch a proxy fight.

The bid is Mr Ballmer's most audacious – and expensive – attempt yet to close the gap with Google, which has snatched more than half of the revenue from search-based advertising. It would be by far the biggest acquisition in Microsoft's history. The urgency of the task has grown since Google's $3.1bn acquisition of DoubleClick, which took it into banner advertising last year. In response, Microsoft paid $6bn for aQuantive, an internet ad agency that rivals DoubleClick. With $40bn being spent annually on internet advertising, neither Microsoft nor Yahoo can afford to cede the race for market share.

But analysts said there were still daunting integration challenges, since Yahoo has a fiercely independent culture and is based in Silicon Valley, far from Microsoft's Seattle headquarters.

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