In its response, Yahoo called the Microsoft bid "unsolicited" but did not reject it.
Microsoft's offer, which was contained in the letter to Yahoo's board, amounts to $31 a share and represents a 62 percent premium over Yahoo's closing price on Thursday. Microsoft said it will offer shareholders the option of cash or stock.
"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," Microsoft CEO Steve Ballmer said in a statement.
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Yahoo said in a responding statement that its board "will evaluate this proposal carefully and promptly, in the context of Yahoo's strategic plans, and pursue the best course of action to maximize long-term value for shareholders."
The deal comes as Microsoft and Yahoo have both struggled to compete against Google.
Microsoft didn't mention Google by name in its announcement, but it did indicate that its acquisition bid was aimed squarely at its rival.
"Today, the market is increasingly dominated by one player, who is consolidating its dominance through acquisition," Microsoft said. "Together, Microsoft and Yahoo can offer a credible alternative."
In a conference call Friday morning, Ballmer said that Microsoft and Yahoo "really do share a vision for the potential of online services."
Microsoft said in its statement that it believes that it can get all of the needed regulatory approvals and that the deal, if ultimately approved by Yahoo shareholders, could be completed in the second half of the year.
Michael Gartenberg, an analyst at Jupiter Research, said it's "clear that there is increased pressure on Microsoft from Google, and they recognize that. Way back when, Yahoo wasn't that interested in a Microsoft deal. What a difference two years make. Microsoft has a pile of money, and Yahoo has experienced problems of its own. Ballmer, in the past, has historically not loved these types of deals. It is indicative of how different the world is now."
Gartenberg added that the deal "absolutely" makes sense. "But there is a lot to be done in the details. Getting this deal done might be the easiest part. The real challenge is what happens when they finish the deal. This is not a panacea--the details will be what matters," he said.
Rumors that Microsoft was interested in Yahoo have bubbled up from time to time, including the past two springs, on the eve of Microsoft advertising conferences.
The move would be by far the largest acquisition ever for Microsoft. Its largest prior deal, also in the online-advertising space, was last year's $6 billion deal to acquire Aquantive.
Asked on the conference call why Microsoft still needs Yahoo after buying Aquantive, Ballmer pointed to Yahoo's reach with consumers.
"Certainly from a consumer perspective, there's no better way to increase scale and capacity than this acquisition," Ballmer said.
Microsoft also pointed to the intense investments needed in data centers and technology needed to compete with Google.
"Scale matters," said Kevin Johnson, president of the Microsoft division that houses Windows and online advertising. "Some of the scale economics can kick in rather rapidly."
Ultimately, Ballmer said, the deal should help Microsoft become profitable in online advertising.
"We've been losing money," Ballmer said. "Our plan would be to not lose money in the future."
In a letter sent to Yahoo's board late Thursday, Microsoft confirmed that it has had talks with Yahoo since 2006 but that its suggestions of an acquisition had been rebuffed.
"In late 2006 and early 2007, we jointly explored a broad range of ways in which our two companies might work together," Microsoft said. "These discussions were based on a vision that the online businesses of Microsoft and Yahoo should be aligned in some way to create a more effective competitor in the online marketplace. We discussed a number of alternatives ranging from commercial partnerships to a merger proposal, which you rejected."
The letter goes on to say that an offer in February 2007 was also rejected. Although at one time, Microsoft was open to other kinds of partnerships with Yahoo, the company says now it just wants to own Yahoo outright.
"While a commercial partnership may have made sense at one time, Microsoft believes that the only alternative now is the combination of Microsoft and Yahoo that we are proposing," Microsoft said in the letter.
In the conference call, Ballmer said that when Microsoft first talked to Yahoo more than a year ago, it believed that a merger would have benefits to both companies.
"We believe now in those benefits more than ever," Ballmer said.
The public offer follows Yahoo's disappointing earnings report on Tuesday, which sent the company's shares down. Yahoo CEO Jerry Yang said Tuesday that the
Terry Semel, Yahoo's former CEO, who left that position last summer but remained as nonexecutive chairman of the board,
Microsoft's move validates Yahoo's value and could bring out other prospective buyers, said Danny Sullivan, editor of Search Engine Land. However, Microsoft doesn't have enough of a plan as to how it would integrate Yahoo into the company, he said.
Unlike with Microsoft's Aquantive and Tellme acquisitions, Microsoft and its Live brands have a lot of overlap with Yahoo, including e-mail, portal, advertising, and search.
"Microsoft suffers in that they are conflicted over two different brands, and now they're going to have to be conflicted over three," Sullivan said. "If Microsoft wants to be a leader in search, this is a way for them to climb up and be No. 2 against Google. And it validates that Yahoo isn't a loser. It's a company that's worth a lot of money."
A merger might give Google some extra competition, but it wouldn't unseat it as the top search provider, and it would take some time to convince advertisers that they would do better on a Microsoft-Yahoo platform over Google's highly successful ad business, said Mark Mahaney of Citigroup.
"If Yahoo wants to remain independent, it will need to show investors that it is willing to take radical, value-creating steps," and outsourcing search to Google is one of its few options, Mahaney wrote in a research note.
Imran Khan of J.P. Morgan Securities thinks that regulators will approve the deal.
"Yahoo is better off inside a larger company with (a) strong balance sheet and technology," Khan wrote in a research note. A merger of Microsoft and Yahoo could give them the scale, in terms of search traffic, that they need to compete against Google and provide a boost on the ad side, he added.
"A combination of Yahoo's relationships (with DSL providers), and Microsoft's applications and devices, could create a very well positioned potential competitor," Khan wrote.
Microsoft's financial advisers are Morgan Stanley and The Blackstone Group.
CNET News.com's Mike Ricciuti contributed to this report.©2007 CNET Networks, Inc. All rights reserved. CNET , CNET.com , and the CNET logo are registered trademarks of CNET Networks, Inc. Used by permission.
