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Memo to Microsoft: Buy Adobe, Not Yahoo

If nothing else, Microsoft’s prolonged attempt to acquire Yahoo has added some zest to the tech news echo chamber. The ongoing saga has provided seemingly endless fodder for mainstream news outlets and blogs to speculate about the financial merits of the deal, the strategic implications for Microsoft and Yahoo’s allergic reaction (a barometer for Silicon Valley sentiment towards the Redmond giant, which remains almost pathologically negative). The Wall Street Journal is reporting today that Steve Ballmer has been given free rein by his board to walk away from the deal or raise his offer (evade the paywall on Google News or read the Silicon Valley Insider summary). Marc Andreesen has a great rundown of the possible outcomes on his blog.

What seems to have fallen by the wayside amongst all the speculation about whether the bid will succeed (and, if so, at what price) is what a spectacularly bad idea it would be. The business landscape is littered with the carcasses of failed mega-mergers (DaimlerChrysler, anyone?). Even when they don’t end in utter disaster, the long-term benefit to shareholders is often dubious. Add to this the fact that Yahoo is so vehemently opposed to the merger that it is seriously contemplating dumping its vaunted Panama ad platform and outsourcing its ad delivery to arch-rival Google. Then consider that industry headhunter Boris Epstein rates concerns about the deal as the number one reason for Yahoo staff defections. Not exactly an environment likely to be conducive to a healthy, happy corporate marriage.

Even more to the point: does a Yahoo acquisition imply the kind of strategic direction that Microsoft should be pursuing? The whole endeavor smells of a vain attempt to hang onto Google’s coattails in the internet search space. Google has hit a grand slam homerun in terms of technology, user experience and monetization, but that doesn’t mean that blindly pursuing the same strategy is the right move for its competitors. Nor is it particularly plausible that combining two also rans (which together would still have less than half of the leader’s market share) will create a viable counterweight to Google’s dominance of the search market.

Microsoft should stick to its knitting: operating systems and applications. Its Silverlight initiative is a step in the right direction, reacting to the inexorable shift of applications onto the web. But they are fighting an uphill battle by trying to achieve any kind of critical mass with a brand new software stack. They’ve tried this before… and when was the last time you used an ActiveX control on the web?

Why not look instead to a company that would instantly turbocharge Microsoft’s web application strategy? Adobe has achieved incredible browser penetration with its Flash runtime. As such is the only company that can plausibly achieve Microsoft’s goal of successfully promoting a framework more suitable for deploying desktop apps on the web than current incarnations of HTML and JavaScript. It has garnered accolades and tremendous mindshare for its AIR platform. And today it announced the Open Screen Project. This initiative offers nothing new on the technology front, but makes it clear that Adobe intends to make a splash in the device market with the elimination of restrictions and licensing fees on its various Flash protocols (SWF, FLV/F4V and Flash Cast), as well as the publishing of APIs that will make it easier for device manufacturers to get Flash running on their cellphones, mobile internet devices, set top boxes and who knows what else. This is exactly where Microsoft wants to be. XBox is its strategic crown jewel, after all, and the addition of Adobe’s technologies to its arsenal might finally pull the Zune out of the doldroms.

A purchase price of $32-33 per share for Yahoo would represent about an 80% increase over the pre-bid stock price. Assuming a similar premium for Adobe, the company would set Microsoft back about $35 billion, a full $10 billion less than Yahoo. It’s far from clear that a big honking acquisition is what Microsoft needs to deal with the decline of its Windows franchise and the challenges it faces as the market moves away from the bulky desktop applications that have served it so well. But if it is going to go this route, Adobe represents the cheaper and more strategically sensible choice.