Microsoft filed its quarterly report with the U.S. Securities and Exchange Commission on Thursday, and in addition to financial revelations about its recent acquisitions, the tech titan also gave a more formal glimpse at how it views and plans to deal with the growing threat posed by Google and Apple, as well as longtime nemesis open source. Microsoft CEO Steve Ballmer touched on many of these issues last week at the start of the company's financial analysts meeting.
In a section titled "Challenges to our business model may reduce our revenues and operating margins," Microsoft reiterated that its bottom line may suffer if it has to drop the prices of its products to compete with Linux.
Proponents of open-source software continue efforts to convince governments worldwide to mandate the use of open-source software in their purchase and deployment of software products. Although we believe our products provide customers with significant advantages in security, productivity, and total cost of ownership, the open-source software model continues to pose a significant challenge to our business model. To the extent open-source software gains increasing market acceptance, sales of our products may decline, we may have to reduce the prices we charge for our products, and revenue and operating margins may decline.
In the same section, Microsoft also pointed to the business model challenge posed by its main search rival which has far more scale. The report seems to express admiration for the business model and says the company is throwing "significant resources" at attempting to emulate it.
Another development is the software-as-a-service business model, under which companies provide applications, data, and related services over the Internet. Providers use primarily advertising or subscription-based revenue models. Recent advances in computing and communications technologies have made this model viable and enabled the rapid growth of some of our competitors. We are devoting significant resources toward developing our own competing software plus services strategies. It is uncertain whether these strategies will be successful.
Another section addresses the threat posed by Apple, while conceding that competing with the model may prove expensive.
An important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A competing vertically-integrated model, in which a single firm controls both the software and hardware elements of a product, has been successful with certain consumer products such as personal computers, mobile phones and digital music players. We also offer vertically-integrated hardware and software products; however, efforts to compete with the vertically integrated model may increase our cost of sales and reduce operating margins.
Also in its report, Microsoft confirmed that it spent $500 million for its acquisition earlier this year of Sidekick maker Danger.
The company also made its larger $1.3 billion purchase of Norway's Fast Search and Transfer and closed its $5.9 billion Aquantive purchase. Other deals made during the year added another $1.1 billion, Microsoft said.
Other interesting Microsoft facts from the report:
Microsoft now occupies 2 million square feet of real estate that it owns and 8 million square feet of leased space.
It ended the year with $23.66 billion in cash and short-term investments, up slightly from the $23.41 billion it had as of June 30, 2007.
That's what I got from a quick read. Let me know if I missed anything.
Updated 1:15 p.m., with comments from Powerset co-founder and Microsoft executive.
Well, first it was a rumor, then an unconfirmed report, and now it's a deal. Microsoft is buying Powerset.
Microsoft confirmed the acquisition Tuesday on its Live Search blog.
"We're excited to announce that we've reached an agreement to acquire Powerset, a San Francisco-based search and natural language company," the company said in the blog posting. Powerset workers will join Microsoft's core search relevance team and remain based in San Francisco. The company said that Powerset's technology will complement existing natural language processing work being done inside Microsoft's research unit.
Terms of the deal were not disclosed, although VentureBeat, which reported last week that the deal was in the works, said Microsoft was paying $100 million or more.
Powerset, which has licensed technology from Xerox's PARC unit, recently made public a tool for searching Wikipedia. The company has 63 employees, all based in San Francisco's South of Market district.
Powerset's Mark Johnson said in a blog post that the company needed deeper pockets to reach its goal.
"With any start-up, the challenge is to take the seeds of an idea and grow it into a viable company," he wrote. "At Powerset, we transformed our idea into a world-class semantic search platform, demonstrating the future of search with our Wikipedia search experience. But building a large-scale semantic search engine is expensive, requiring an engineering effort and computing resources beyond what most start-ups could ever imagine...We believe that this is the fastest way to bring our technology to market at a large scale."
In November 2006, Powerset said it had landed $12.5 million in Series A funding from Foundation Capital, Founders Fund, and angel investors.
Update: In an interview, Microsoft's Ramez Namm said that Powerset's technology will help Microsoft in its long-term effort to create a more ideal type of search, but said there are also some things that could be applied to Live Search soon, although he wouldn't offer any specifics.
Namm declined to take a stab at how long or how much it would cost to take Powerset's approach and apply it to the web, but Powerset CTO Barney Pell did say that the two main hurdles to that--limited hardware resources and having its own core search product--were now removed. Pell added that search, and natural language search in particular, were likely to be at the center of innovation for the next 20 years.
As for the broad areas where natural language search would help, Namm pointed to the fact that search results today are heavily dependent on using the same wording as the page you want, rather than understanding the meaning of a query.
"Search engines force the user to figure out what words might be used on the right page," he said. "That makes it much harder than it has to be."
Pell declined to say whether Microsoft faced any other active bidders in trying to buy the company and both companies refused to talk about the deal's financial terms.
Also check out this post, for more analysis from News.com's Dan Farber.
Microsoft said late Tuesday that it has bought Navic Networks, a company that helps television advertisers manage their ad campaigns.
The move will gives Microsoft a broader reach into the spot where advertisers spend the most.
"Television media represents the largest percentage of advertisers and agencies' media budget today," Microsoft Senior Vice President Brian McAndrews said in a statement. "Together, Navic and Microsoft will deliver addressable television advertising solutions to help our partners better manage media spend by increasing advertiser reach and ROI, and maximizing publisher yield on television advertising."
The move comes just six days after the company failed to reach an accord with Yahoo, leading the Internet giant to strike an ad deal with Google instead.
Based in Waltham, Mass., Navic has raised $43 million in three rounds of funding, according to its Web site. Investors include: Pilot House Associates, Highland Capital Partners, Himalaya Capital Ventures, and Pequot Ventures.
Despite a brief moment of optimism heading into Saturday, Microsoft and Yahoo were really never closer to doing a merger deal than two ships passing in the night.
There was almost no discussion of price, and those talks that were held suggested to Microsoft that Yahoo was never really prepared to sell itself to the software company, according to a source familiar with the negotiations.
News.com Poll
A source familiar with Yahoo's negotiating stance disputed the characterization. However, judging by Yahoo's relative intransigence on price and insistence on several other requirements, it's clear the company wasn't eager to strike a deal. The company didn't want to let it itself be sold at what it deemed a "fire sale" price, the source familiar with Yahoo's position said.
Yahoo wasn't eager to rush things. Although Microsoft made its
Asked by Microsoft CEO Steve Ballmer where Yahoo stood on a takeover price, Yahoo executives responded that they didn't really have one. On April 18, there was a follow-up call with five bankers representing the two companies, sources familiar with the negotiations said. Yahoo's bankers indicated during the call that the company was only prepared to do a friendly deal at $40 a share or higher, sources said; Yahoo began its negotiations with that price because that's what Microsoft had offered in a bid to acquire Yahoo in 2006. That was the only discussion on price until this week, one source said.
Yahoo indicated to Microsoft this week that it might be willing to do a deal at a price lower than $40, and Microsoft later told Yahoo that it was willing to increase its offer by a couple dollars a share. On Friday, Microsoft said it was willing to offer $33 a share, which it viewed as a substantial increase from its original offer given that the original cash-and-stock offer had dropped below $30 a share.
The two sides arranged agreed to meet face-to-face at Seattle's Sea-Tac airport to discuss the revised positions. Microsoft and its bankers headed into the meeting with a fair amount of optimism because that they believed Yahoo shareholders were willing to do a deal at close to Microsoft's improved offer of $33 a share. However, at the meeting, Yahoo co-founders Jerry Yang and David Filo said their board was willing to do a deal around $37 a share, but that they would rather see a deal at around $38 a share.
The disagreements were not confined to price, sources said. Shortly after the April 15 Portland meeting, Yahoo gave Microsoft a list of nonfinancial deal terms.
"They were complete non-starters," one source said.
Yahoo wanted Microsoft to go through an antitrust review that Microsoft believed would have take several months to complete, sources said. One particular area of concern to Yahoo was the combined strength in e-mail that would Microsoft would have by combining Yahoo Mail and Microsoft's Hotmail, and the complications and risks of splitting off parts of the combined business, one source said.
Other conditions that rankled included a breakup fee--essentially, money Microsoft would have to commit to pay to compensate Yahoo in case the deal fell through down the road because of some issue such as regulatory review. And Microsoft was strongly displeased with a provision, added to Yahoo bylaws after Microsoft announced its acquisition proposal, that would require severance payments to all Yahoo employees in the event of acquisition-related layoffs.
"Jerry didn't want to sell the company," one source familiar with the negotiations said.
The source declined to go into specifics regarding Yahoo's demand for review, but said the two sides were as far apart on nonfinancial issues as they were on financial ones.
CNET News.com's Stephen Shankland contributed to this report.
Here is the text of an internal memo Microsoft CEO Steve Ballmer sent Saturday afternoon to Microsoft employees:
From: Steve Ballmer
Sent: Saturday, May 03, 2008 5:18 PM
To: Microsoft - All Employees (QBDG)
Subject: Withdrawal of Offer to Acquire Yahoo!
This afternoon I sent the attached letter to Jerry Yang announcing that Microsoft has withdrawn its proposal to acquire Yahoo. We proposed the deal in the belief that a Microsoft-Yahoo merger would create a combined company with the resources and assets to win in the fast-growing market for advertising and online services.
Although the acquisition of Yahoo would have accelerated our ability to deliver on our strategy in advertising and online services, I remain confident that we can achieve our goals without Yahoo. We have a strategy in place to do so and we will continue to expand on this strategy and accelerate our progress.
Our strategy has three components:
•Deliver on the basics. We will continue to improve search relevance and build out our ad platform.
•Change the game through innovation. We will expand investments in engineering and deliver transformative tools and Web experiences.
•Expand our global scale and focus. We will pursue partnerships and investments to realize the competitive advantages that come with scale.
At the heart of our strategy is a commitment to bring the benefits of competition, choice, and innovation to everyone who uses the Internet--from consumers to content creators to advertisers.
We are 100 percent focused on executing on this strategy and we have made good progress in a very short time. We've improved search relevance dramatically, introduced compelling new search verticals, successfully integrated Aquantive, and added nearly 100 new publishers to our ad platform. In the last couple of months we've rolled out new versions of key products including Internet Explorer and Silverlight, and introduced new technologies like Live Mesh. We now have over 430 million active users of our Windows Live services worldwide. And we continue to add new technologies with acquisitions such as YaData, which brings leading-edge behavioral targeting technology, and Caligari, which gives us advanced 3D modeling capabilities that will help us continue to improve Virtual Earth.
Ultimately, our goal is to build the industry-leading business in search, online advertising, media, and social networking.
We are absolutely committed to being the leader in each of these areas. Now is the time to do what we have always done best--be tenacious, focus on the long term, innovate, and keep working hard.
I want to thank all of you for your patience during this process and for your dedication and hard work across all of our businesses. We asked that you remain focused on our goals through these cycles, and you have done this extremely well. We are committed to making the investments that will enable us to compete and, ultimately, lead in the online services and advertising businesses. Together, I know we will succeed.
Steve
Microsoft says its offer for Yahoo is off the table, but could this be just a negotiating ploy?
It's a natural question to ask. I mean, if Microsoft has had the hots for Yahoo for two years, can it really be so sure that it is no longer interested?
News.com Poll
My take is that Microsoft has ruled out two options, but that one possibility for Yahoo remains out there.
Clearly, Microsoft is not having luck getting Yahoo to consider the price it is willing to pay, so the direct option hasn't worked. CEO Steve Ballmer says that Microsoft has also ruled out going directly to shareholders, a move that would likely require a nasty, costly, and time-consuming proxy fight.
In particular, Yahoo has proven itself adept at making itself a less attractive takeover target. In addition to the usual sorts of poison pill defenses, it has found other weapons like cutting sweetheart deals for employees and negotiating a partnership with Google, the very company Microsoft is looking to rival.
Such a move might not pass regulatory muster, but Ballmer indicated in his letter to Yahoo's Jerry Yang that Yahoo's moves have succeeded in making the proxy battle sufficiently unattractive.
"Our discussions with you have led us to conclude that, in the interim, you would take steps that would make Yahoo undesirable as an acquisition for Microsoft," Ballmer wrote. "We regard with particular concern your apparent planning to respond to a 'hostile' bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo today."
From my point of view, though, it doesn't mean Microhoo is totally dead. Even though several doors seem closed, I see one door that could swing back open. Yahoo shareholders may find it tough to swallow the fact that Yang said no to $33 a share and push him back to the negotiating table. In that scenario, the Yahoo that Microsoft finds so attractive could once again be on the market.
There's also the possibility that Yahoo tries to go it alone for a little while, stumbles, and Microsoft comes back with a new offer.
For his part, Gartner analyst Allen Weiner thinks Microsoft really did walk away. "I think the drama is pretty close to being over," he said. Microsoft and Yahoo both think they can rebuild themselves to their glory days on their own, he said.
That's not to say that a good feint can't seal a deal.
Oracle walked away from its bid for software maker BEA Systems when the companies couldn't come close to a price. But both companies returned to the table and ultimately negotiated an amicable deal. (Though it's also worth noting that Oracle ended up paying far more than its original offer.)
News.com's Stephen Shankland contributed to this report.
With Yahoo apparently off the table, it's time to see what Microsoft's back-up plan looks like.
Microsoft has said for some time that it has a strategy with or without Yahoo, but it's a strategy clearly in need of a jump-start.
In search, for example, Microsoft has been trying to take on Google for some time, but it remains a distant third in search queries and also has struggled in the all-important battle of monetizing each search query.
Microsoft outlined two key reasons for buying Yahoo--adding its talented engineers and getting the significant boost in scale that would come from buying the No. 2 player.
Clearly, Microsoft could use just a fraction of those billions and get a ton of engineering talent. The scale problem, however, is a more challenging one. As Microsoft CEO Steve Ballmer himself said in a meeting with employees on Thursday, there just aren't that many companies out there with any significant scale.
As for where else the company may look, Ballmer's recent comments to The Wall Street Journal offer a cheat sheet to the short list.
"There's really only five or six that really have any scale," Ballmer said in that interview. "Worldwide, you'd maybe get seven or eight."
Among those companies with scale that Ballmer named were Facebook, MySpace.com, and AOL, along with the Yahoo, Google, and Microsoft itself.
Although Facebook and MySpace have huge audiences, selling advertising against those sites has proved to be trickier than in search. Plus, Microsoft had to agree to a massive $15 billion valuation for Facebook just to get an ad deal and a small slice of the company. MySpace, meanwhile, has an add tie-up with Google. AOL is certainly seen as in play, having been a frequent rumor target as a potential partner for Yahoo.
Still, Ballmer said in his letter to Yang and in a public statement that he will look at other business moves and may expect other deals to follow.
"I wouldn't be surprised to see Microsoft going on a buying spree to buy some of the things they thought they might be getting from Yahoo," said Gartner analyst Allen Weiner. "I think they'll look seriously at some of the significant Web 2.0 companies and what they might add to the Microsoft label."
There's also the possibility that Microsoft makes another try at Yahoo once the dust settles a bit. I'll explore this in a follow-up piece.
News.com's Stephen Shankland contributed to this report.
Here is the text of the letter Microsoft CEO Steve Ballmer sent to Yahoo chief Jerry Yang after talks broke down on Saturday.
May 3, 2008
Mr. Jerry Yang
CEO and Chief Yahoo
Yahoo! Inc.
701 First Avenue
Sunnyvale, CA 94089
Dear Jerry:
After over three months, we have reached the conclusion of the process regarding a possible combination of Microsoft and Yahoo!.
I first want to convey my personal thanks to you, your management team, and Yahoo!’s Board of Directors for your consideration of our proposal. I appreciate the time and attention all of you have given to this matter, and I especially appreciate the time that you have invested personally. I feel that our discussions this week have been particularly useful, providing me for the first time with real clarity on what is and is not possible.
I am disappointed that Yahoo! has not moved towards accepting our offer. I first called you with our offer on January 31 because I believed that a combination of our two companies would have created real value for our respective shareholders and would have provided consumers, publishers, and advertisers with greater innovation and choice in the marketplace. Our decision to offer a 62 percent premium at that time reflected the strength of these convictions.
In our conversations this week, we conveyed our willingness to raise our offer to $33.00 per share, reflecting again our belief in this collective opportunity. This increase would have added approximately another $5 billion of value to your shareholders, compared to the current value of our initial offer. It also would have reflected a premium of over 70 percent compared to the price at which your stock closed on January 31. Yet it has proven insufficient, as your final position insisted on Microsoft paying yet another $5 billion or more, or at least another $4 per share above our $33.00 offer.
Also, after giving this week's conversations further thought, it is clear to me that it is not sensible for Microsoft to take our offer directly to your shareholders. This approach would necessarily involve a protracted proxy contest and eventually an exchange offer. Our discussions with you have led us to conclude that, in the interim, you would take steps that would make Yahoo! undesirable as an acquisition for Microsoft.
We regard with particular concern your apparent planning to respond to a “hostile” bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo! today. In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo! undesirable to us for a number of reasons:
•First, it would fundamentally undermine Yahoo!’s own strategy and long-term viability by encouraging advertisers to use Google as opposed to your Panama paid search system. This would also fragment your search advertising and display advertising strategies and the ecosystem surrounding them. This would undermine the reliance on your display advertising business to fuel future growth.
•Given this, it would impair Yahoo’s ability to retain the talented engineers working on advertising systems that are important to our interest in a combination of our companies.
•In addition, it would raise a host of regulatory and legal problems that no acquirer, including Microsoft, would want to inherit. Among other things, this would consolidate market share with the already-dominant paid search provider in a manner that would reduce competition and choice in the marketplace.
•This would also effectively enable Google to set the prices for key search terms on both their and your search platforms and, in the process, raise prices charged to advertisers on Yahoo. In addition to whatever resulting legal problems, this seems unwise from a business perspective unless in fact one simply wishes to use this as a vehicle to exit the paid search business in favor of Google.
•It could foreclose any chance of a combination with any other search provider that is not already relying on Google’s search services.
Accordingly, your apparent plan to pursue such an arrangement in the event of a proxy contest or exchange offer leads me to the firm decision not to pursue such a path. Instead, I hereby formally withdraw Microsoft’s proposal to acquire Yahoo!.
We will move forward and will continue to innovate and grow our business at Microsoft with the talented team we have in place and potentially through strategic transactions with other business partners.
I still believe even today that our offer remains the only alternative put forward that provides your stockholders full and fair value for their shares. By failing to reach an agreement with us, you and your stockholders have left significant value on the table.
But clearly a deal is not to be.
Thank you again for the time we have spent together discussing this.
Sincerely yours,
/s/ Steven A. Ballmer
Steven A. Ballmer
Chief Executive Officer
Microsoft Corporation
Microsoft officially pulled its offer for Yahoo on Saturday, confirming an earlier report by CNET News.com.
In a letter to Yahoo CEO Jerry Yang, Microsoft chief Steve Ballmer confirmed that Microsoft was willing to offer $33 a share, but that Yahoo was holding out for at least $37 a share, or $5 billion more than Microsoft was prepared to spend. In the letter, Ballmer also says he is ruling out a direct offer to shareholders.
News.com Poll
"This approach would necessarily involve a protracted proxy contest and eventually an exchange offer," Ballmer said. "Our discussions with you have led us to conclude that, in the interim, you would take steps that would make Yahoo undesirable as an acquisition for Microsoft."
Ballmer specifically pointed to Yahoo's plan to outsource its paid search to Google. "We regard with particular concern your apparent planning to respond to a 'hostile' bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo today," Ballmer said.
Such a move, Ballmer wrote, would undermine Yahoo's strategy and long-term viability, hurt its ability to retain engineers, and pose regulatory and legal problems.
Ballmer said in a statement that Microsoft would pursue its own strategy.
"After careful consideration, we believe the economics demanded by Yahoo do not make sense for us, and it is in the best interests of Microsoft stockholders, employees and other stakeholders to withdraw our proposal," he said. "We have a talented team in place and a compelling plan to grow our business through innovative new services and strategic transactions with other business partners. While Yahoo would have accelerated our strategy, I am confident that we can continue to move forward toward our goals."
In the letter to Yang, Ballmer again made the case that Microsoft's offer was the best option for Yahoo shareholders.
"I still believe even today that our offer remains the only alternative put forward that provides your stockholders full and fair value for their shares," Ballmer said. "By failing to reach an agreement with us, you and your stockholders have left significant value on the table. But clearly a deal is not to be."
Update 5 p.m. PDT: Microsoft has made its move official. Click here for the story and here for the text of a letter Ballmer sent to Yang.
Microsoft is withdrawing its offer for Yahoo after talks between the two companies broke down on Saturday, a source told CNET News.com.
News.com Poll
Microsoft hiked its offer to $33 a share, but Yahoo was holding out for $37 a share, the source said. The two sides met face to face again Saturday, but remained far apart.
Although price was a key issue, Microsoft also had strategic concerns and saw it as unlikely to achieve a friendly integration process. According to a source close to Microsoft, Yahoo founder and CEO Jerry Yang had "unrealistic expectations."
Microsoft made its $31 a share cash and stock offer on February 1. Yahoo rejected the bid as undervaluing the company, and the two sides had only the most basic of negotiations until Microsoft set a three-week deadline last month. Negotiations heated up on Friday, but the two sides remained far apart.
The move leaves both companies in a tenuous spot. Although Microsoft has said it has a strategy to take on Google without Yahoo, Yahoo represented the biggest opportunity for Microsoft to gain scale against its rival, which has a much larger Internet advertising business.
Yahoo, meanwhile, has had talks with AOL and Google, but it is unclear whether deals with either would produce the kind of immediate return for shareholders that a Microsoft deal would offer.
Microsoft is expected to announce its move publicly shortly, according to the source.
