REDMOND, WASHINGTON (AP), FEBRUARY 2, 2008 (STAR) Microsoft Corp. is offering $44.6 billion in cash and stock for search engine operator Yahoo Inc. in a move to boost its competitive edge in the online services market.

The unexpected announcement Friday comes as Microsoft, the world’s biggest software company, seeks new ways to compete more effectively against the search and online advertising powerhouse Google Inc.

In a letter to Yahoo’s board of directors, Microsoft CEO Steve Ballmer said the company will bid $31 per share, representing a 62 percent premium to Yahoo’s closing stock price Thursday, and emphasized that the deal is not subject to financing.

“In February 2007, I received a letter from your chairman indicating the view of the Yahoo board that “now is not the right time from the perspective of our shareholders to enter into discussions regarding an acquisition transaction,” Ballmer wrote.

“According to that letter, the principal reason for this view was the Yahoo board’s confidence in the “potential upside” if management successfully executed on a reformulated strategy based on certain operational initiatives, such as Project Panama, and a significant organizational realignment.”

“A year has gone by, and the competitive situation has not improved,” Ballmer added.

Under terms of the proposed deal, Yahoo shareholders could choose to receive cash or Microsoft common shares, with the total purchase consisting of 50 percent each cash and stock.

Microsoft said it sees at least $1 billion cost savings generated by the merger, and intends to offer significant retention packages to Yahoo engineers, key leaders and employees. The software giant said it believes the takeover would receive regulatory clearance and close in the second half of 2008.

What Microsoft's Yahoo bid means for Google By David Kirkpatrick, senior editor, FORTUNE 500 Current Issue 

Microsoft and Yahoo are the only two companies that can combine and give the Net's colossus a run for its money. Somebody needs to. By David Kirkpatrick, senior editor Sign up for the Fast Forward e-mail newsletter

(Fortune) -- With Google's stock already down considerably in recent weeks, the Web's next two most powerful players today struck a powerful blow for equality and influence in the increasingly-important Web ecosystem.

Wonderful as Google is, the world and the entire Internet and media industry needs for its power to be countered and, if possible, matched. Genuine competition drives innovation. Without, everybody loses.

Google has gotten so large and dominant on the Net that it was only a matter of time before it began to encounter regulatory restraints, especially in Europe. A Yahoo-enhanced Microsoft could actually be a perverse benefit for Google by keeping those overseers off its back.

Search remains the Web's best business. That's where the lion's share of ad dollars are spent, and Google controls more than 60% of it. Together, Microsoft and Yahoo will own almost 30%. If they can hold onto it that's enough to be a meaningful competitor.

Microsoft controls a huge and multifaceted Web presence, and retains still-almost-unlimited financial resources. The combination of all that with Yahoo's superior Web brand and deeply entrenched position as a marketplace for display advertising and online media is probably the only one that can begin to match the Google machine.

And since search is a game of scale, the two combining companies each acquire exponentially greater power than either could command on their own. Like buyers and sellers of goods on eBay, both buyers and sellers of search ads want to do business where there is the largest number of counterparties. If there aren't a lot of sellers you don't want to buy ads from Microsoft - or anyone.

Both Microsoft and Yahoo have also been working to address this problem by acquiring impartial ad-marketplaces in the last year. Microsoft stunned the world by paying over $6 billion for aQuantive, signaling for the first time how serious it was not to be left behind by Google.

Separately, Microsoft still exercises unparalleled influence on the devices that the people of the planet use to connect to the Web. Its monopoly on desktop software remains essentially unbroken despite inroads from Apple and open source. And in the all-important area of mobile it has in the last year or so shown it finally is getting traction from handset makers worldwide, especially in the developing world and China.

As for Yahoo, it still hangs on to its bragging rights as the most-visited set of sites on the web, even though Google has been threatening in recent months to overtake it as its strength, particularly in developing markets, grows and grows.

Finally, the financial resources of Microsoft (MSFT, Fortune 500) could prove critical for keeping Yahoo's businesses viable in the face of the Google (GOOG, Fortune 500) onslaught. Very few companies can afford the billions in investment - especially in data centers and infrastructure - that will be required going forward to compete globally in search, advertising placement, and mobile content delivery. Yahoo alone simply didn't have the cash. Microsoft does.

As Imran Khan, analyst at J.P. Morgan Securities wrote in his note on the deal this morning, "A combination of Yahoo's relationships and Microsoft's applications and devices could create a very well-positioned competitor" for Google.

All media is slowly moving towards the Web, along with advertising. The complexities of targetting, delivering, formatting, and promoting that content grow ever greater with the move toward mobility and as the television too gets pulled towards the Web. In the all-digital world we are entering, the distinctions between on-Web and off will increasingly disappear. So to command the marketplaces and platforms for digital content is, for both tech and media companies, the most important mandate.

Google (GOOG, Fortune 500) has the clear lead among all companies in achieving such command. But today we've seen the beginnings of a bi-polar Internet. It will influence and rearrange the competitive alliances and strategy of just about every company that aspires to a digital future.

Chief News Editor: Sol Jose Vanzi

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