Microsoft's Revenge

Microsoft has been kicked around the block in the Internet business for going on 15 years. Now it is potentially payback time.

While everyone else hunkers down and fights to survive, Microsoft gets to sit back and decide who to buy. When it decides, it can dig into a $20 billion cash pile that will nearly replenish itself this year with $15 billion of free cash flow. No one else, including Google, will gain this much of a relative advantage from the global economic collapse.

(Google, moreover, is now hamstrung by alert regulators--thanks, in part, to Microsoft's lobbying--and is focused on cutting costs and narrowing its ambitions. These should keep it distracted for the next couple of years.)

Who could Microsoft buy?  Some obvious names, and many smaller not-so-obvious ones.

But the first thing Microsoft needs to do if it is to succeed long-term in the Internet business is build a central consumer brand that it can hang everything else off of. (Alternatively, it can focus on the back end, via search and other technologies, but this likely won't be as profitable. The vast majority of Google's immense profit comes from searches on its own site, not third-party sites, and the same will hold true for Microsoft).

The big consumer Internet brands other than Google include:

• Yahoo
• AOL
• Facebook
• MSN, et al (Microsoft needs to consolidate ALL its Internet brands into one. This one's probably the most prominent).

Microsoft could probably buy Yahoo, AOL, and Facebook today for $20 billion of cash. It could then consolidate them under a single brand and build a strong alternative for advertisers vis a vis Google. (Vastly easier said than done, but possible.)

If Microsoft isn't willing to put all its weight behind a single brand, it will probably fail regardless of what it buys. This has been Microsoft's Achilles heel for the past 15 years--an unwillingness to commit to one Internet brand and strategy--and we're not optimistic that it will be able to get out of its own way this time either.

We still think the smart play here would be for Microsoft to spin its Internet operations OUT of Microsoft and INTO Yahoo and then build everything around that brand as a separate public company. We think Steve Ballmer is congenitally predisposed against this approach, however, even though it would likely be a great move for Microsoft shareholders (who would own most of the new Yahoo AND the original Microsoft).

But, in any event, as the Valley goes into the fetal position, Microsoft's relative position is growing stronger. And we imagine this is not lost on the folks in Redmond.