The Future Belongs to Google

I wrote an article for Kelly Letter subscribers last week explaining how both Google and Yahoo are racing to deliver online alternatives to Microsoft Windows and Microsoft Office.

Google Docs is already pretty far along toward replacing Office, but the much bigger fish for the future will be a freely downloadable internet based operating system that can replace Windows.

That article could not have been timelier.

Indeed, Microsoft was so concerned about the internet threat that it made a bid to buy Yahoo for $42 billion last Friday. Prior to that, the largest acquisition Microsoft ever made was online ad company aQuantive for $6 billion last year. The huge offer for Yahoo shows how serious Microsoft feels about the internet’s role in its future.

The cash-and-stock offer was worth $31 per share of YHOO as of Thursday’s close, but only $28.95 per share as of Friday’s close because shares of MSFT fell on news of the bid.

This changes everything.

My thinking on Yahoo for the past two years has been that it would command as much of the growing online advertising pie as Google. The online ad market in 2007 was about $40 billion. Because more people are getting more of their information online, online ads are on trend to hit $80 billion by 2010.

Yahoo has made great strides forward since 2004 when Google hit pay dirt with its fantastic ad system. Yahoo overhauled its own advertising platform with a new one called Panama that’s doing well. It increased overall traffic and is the most visited online name. It made smart acquisitions including Flickr, the web’s most popular photo site. It also snazzed up all of its properties, most notably Yahoo Mail and Yahoo Finance.

What it did not do was take search market share from Google. To this point, that’s about all Yahoo has left to focus on and it’s focusing on it very hard.

What I posited last week was that both Google and Yahoo had their sights set on delivering the world’s first internet based operating system alternative to Windows and other hard-drive based operating systems. The first company to bring that to the world stands to unseat Microsoft from its dominant position at the center of computing, control most of the online ad market and, indeed, become to the internet what Microsoft has been to the hard-drive based personal computer.

While I felt it was too soon to say whether Google or Yahoo was farther ahead in the effort, I was willing to continue betting on Yahoo because of its cheap valuation. Part of the reason is now abundantly clear. Even if Yahoo couldn’t make it on its own, it was a fabulous takeover candidate.

The Kelly Letter owns both Microsoft and Yahoo, and did well overall on the news. MSFT dropped 6.6% but YHOO gained 48%.

Microsoft has not purchased Yahoo yet. We need to be clear on that. It made a bid. Yahoo did not offer itself for sale. The only thing Yahoo had to say Friday was that its board will carefully consider the offer.

Microsoft President Steve Ballmer said on a conference call Friday, “This is a decision we have — and I have — thought long and hard about. We are confident it’s the right path for Microsoft and Yahoo.”

From which we should assume Microsoft will not give up easily.

Yahoo, however, may not give up its independence easily. Forrester Research analyst Charlene Li even suggested Yahoo would outsource its search engine operation to Google if that kept it out of Microsoft’s jaws. About that idea, Paul Kedrosky wrote, “Ironic, huh? Yahoo needs Google to save it from Microsoft to save it from Google.”

Other suitors will undoubtedly show up, and already lists of possibilities are making their way around the internet. That would be good for Kelly Letter subscribers as YHOO owners, because more demand will drive up the price.

Where does that leave us?

For now, right where we’ve been all along with shares of MSFT for its reinvigorated profits from new software versions. The company is in no danger of being unseated in the next year or so.

As for Yahoo, I’m interested in it only as an independent company. We’ll gladly hold shares while they appreciate in the hot light of merger demand, but that’ll be the end.

Beyond that, for the first time, I’m willing to say the future belongs to Google. I believe Microsoft will destroy the chance Yahoo had because the best thing Yahoo had going for it was the potential to integrate all it had built over the years into an internet-based desktop that anybody could download for free.

Microsoft could kill that project. Doing so would be stupid, though, because it would leave only Google working on it and leave Microsoft as vulnerable as it is right now. There would be little point in acquiring Yahoo.

More likely, Microsoft will make the Yahoo desktop into the online version of Windows Vista. That will do nothing to give people what they’ve wanted all along, which is an alternative to Microsoft’s iron grip on computing. The Micrahoo Vista Internet Desktop will be a colossal thud, encumbered by Microsoft’s infamous complexity and mired in all the monopolistic hooks and dependencies called “features” in everything from Redmond.

It will be the entire marketing plan around the far superior, simple, elegant, and independent desktop on the way from Google. The only tagline Google’s desktop will need is, “The one that ain’t from Microsoft.”

This is great news for Google. Its only rival is in danger of disappearing into the un-innovative maw of Microsoft, the same company that made Hotmail an also-ran in online mail, and cemented MSN’s position as such a distant alternative to Google and Yahoo that nobody even mentions it except to make fun of Microsoft.

That makes The Kelly Letter’s new strategy straightforward. We’ll hold YHOO while the bidding takes place. If it’s acquired by Microsoft, we’ll combine the shares we get in return with the ones we already own, and start looking for an exit point.

Finally — drum roll, please — for the first time ever we’ll be looking to buy shares of Google. I’ve been watching GOOG for years, and it’s always looked too expensive. With its recent profit pace slowing, the share price has fallen 30% since November 6, making it more tantalizing than it’s been in a while.

What I’m hoping for is a widespread misunderstanding that Microsoft acquiring Yahoo is going to create the tag team that will take Google down for good. That, combined with Google’s slowing profit growth and remaining development time of Google’s internet-based operating system, may depress the price of GOOG even further.

This could give us a perfect chance to sell Micrahoo at a profit, and bet on Google.

Breaking news hints that we may get precisely that scenario. Google itself is creating the impression, as reported by the Associated Press:

Microsoft has been trying to depict a Yahoo takeover as a boon for both advertisers and consumers because the two companies together would be able to compete against Google more effectively.

But Google is painting a starkly different picture, asserting that Microsoft will be able to stifle innovation and leverage its dominating Windows operating system to set up personal computers so consumers are automatically steered to online services, such as e-mail and instant messaging, controlled by the world’s largest software maker.

In a move that illustrates just how badly Google wants to torpedo the deal, Google Chief Executive Officer Eric Schmidt called Yahoo CEO Jerry Yang Friday to offer his help in repelling Microsoft, according to a report Sunday on The Wall Street Journal’s Web site, which cited anonymous people familiar with the matter.

full article

See what I mean? Everybody knows Microsoft’s tricks. Everybody knows it wants to make the same mess of the internet that it made of the personal computer, with all money channeling back to it as it puts up barriers to innovation in all directions. Everybody’s sick of Microsoft.

Microsoft should well be terrified of the day a free online alternative to Windows hits the internet. Starting on that day, the countdown to Microsoft’s irrelevance could be measured in quarters, not years.

You know how long it would take me to switch? Only as long as the download. When the installation prompt asked me if I wanted to save a backup copy of my former operating environment, I’d click “hell no” as fast as my fingers could move.

And — poof! — just like that Microsoft would be gone.

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