MSFT and YHOO

Microsoft Corp. made an unsolicited $44.6 billion cash and stock bid for Yahoo on Friday, a deal that could shake up the competitive and lucrative market for Internet search.

The deal would pay Yahoo shareholders $31 a share, which represents a 62% premium from where Yahoo stock closed on Thursday.

Steve Ballmer, Microsoft's chief executive, called the move the "next major milestone" for the software giant.

"We are very, very confident this is the right path for Microsoft and for Yahoo," he said.

Ballmer, saying that Microsoft has been in "off and on" talks with Yahoo for 18 months, said he called Yahoo CEO Jerry Yang Thursday night to tell him about the bid.

Microsoft made the bid early Friday. In a statement, the company said the offer allows Yahoo shareholders to elect to receive cash or a fixed number of shares of Microsoft common stock, with the software giant's offer consisting of one-half cash and one-half Microsoft common stock.

Shares of Yahoo (YHOO, Fortune 500) shot up nearly 60% in pre-market trading on the news, while shares of Dow component Microsoft (MSFT, Fortune 500) tumbled 5%.

In a statement, Yahoo acknowledged receipt of the offer and said its board would evaluate the proposal "carefully and promptly."

Both Microsoft and Yahoo have fallen far behind rival Google (GOOG, Fortune 500) in the lucrative field of Internet search. Yahoo's earnings and share of the online search market have badly trailed Google.

In a letter it sent to Yahoo's board of directors, Microsoft disclosed it had explored a Microsoft-Yahoo deal a year earlier, only to be rebuffed by Yahoo, which said at that time it was confident of the "potential upside" for Yahoo from operational changes it planned.

"A year has gone by, and the competitive situation has not improved," Ballmer.

On Thursday, former Yahoo Chief Terry Semel, who opposed an earlier approach Microsoft made last year, resigned from the Yahoo board.

Yahoo announced Tuesday it would lay off 1,000 employees by mid-February, citing what CEO Yang described as "headwinds" facing the company. It also reported lower fourth-quarter earnings that still beat Wall Street's now modest expectations for the firm, but it gave a 2008 revenue forecast that disappointed analysts.

Talkback: Is it time for Yahoo to sell-out?
But even Google has run into recent problems. After the bell Thursday it reported earnings that fell a penny a share short of forecasts. The company reported a slowdown in its fourth-quarter revenue growth, attributed partly to difficulty selling ads on social networking sites.

Google shares have fallen 24% since hitting a record high $747.24 in early November. But Yahoo shares have lost more than a third of their value over the same period.

Still, online advertising, particularly ads tied to Internet search, is by far the fastest growing part of ad spending. That's caused problems for traditional media, which have seen ad spending fall.

Microsoft said it projects the online advertising market to grow from over $40 billion in 2007 to nearly $80 billion by 2010.

In the letter to Yahoo's board, Microsoft said a tie-up would achieve economics of scale while allowing combined research and development efforts to achieve breakthrough products, particularly in the growing areas of online video and mobile Internet connections.

Microsoft said it intends to offer significant retention packages to Yahoo engineers, key leaders and employees across the firm. It said it believes the proposed combination would receive all necessary regulatory approvals and expects that the proposed transaction would be completed in the second half of calendar year 2008.

"We have great respect for Yahoo, and together we can offer an increasingly exciting set of solutions for consumers, publishers and advertisers while becoming better positioned to compete in the online services market," Ballmer said in the company's statement.