For Once, The Underdog

Microsoft not only needs the cash to buy Yahoo!; it needs permission. Yet for once, it might find facing antitrust regulators relatively easy. In both the U.S. and Europe, Google dominates online advertising and search. Some healthy competition would be welcome. But that doesn't mean approval will happen overnight.

In the U.S., the potential merger would either have to be scrutinized by the Department of Justice or the Federal Trade Commission if Yahoo! (nasdaq: YHOO - news - people ) accepts Microsoft's (nasdaq: MSFT - news - people ) offer. The two agencies would literally sit down to decide which one would oversee the merger consideration. As of yet, it's not clear which one would do this. A Justice Department official says that the agency would be "interested" in scrutinizing the deal; FTC officials declined to comment.

The European Commission, stricter about market dominance than the Department of Justice, wouldn't comment on the deal Friday, but said that it was awaiting notification from Microsoft. It won't start an investigation until a deal is "implemented."

Microsoft is already dealing with regulatory hurdles in both America and Europe. In the U.S. a federal judge ruled earlier this week that Microsoft's compliance with a 2002 antitrust settlement would remain under court supervision until November 2009. The Justice Department has said that case is "a different matter" from the current bid for Yahoo!.

Meanwhile, Microsoft's Web browser is a sticking point in Europe. Only two weeks ago the Commission said it was launching a phase-two antitrust investigation against Microsoft that included looking into the tying of Internet Explorer into Windows, and IE's proprietary technology, which allegedly makes it incompatible with other competing browsers.

The whole idea of tying browsers and downloadable software like Media Player into Windows doesn't sit well with the European Commission, so Microsoft will have to tread carefully when it explains how it plans to create that $1 billion in synergies with Yahoo!. Bundling Yahoo!'s software into Windows--think free e-mail and instant-messaging services--would probably be a no-no.

"Linking their dominant position in the operating system market with the search engine services has been seen as abusive behavior," said Hans Friederiszick of ESMT Competition Analysis in Berlin. "If they implement this strategy, they'll get even higher fines."

U.S. Sen. Herb Kohl, D-Wisc., chairman of the Senate's antitrust subcommittee, says his panel will scrub the deal to ensure that it doesn't promote anticompetitive behavior. The committee doesn't have any teeth, so to speak, but it does have the ability to delay a merger by exposing problems it feels federal regulators should scrutinize.

And, at least in theory, any U.S. state could sue to block the transaction, though this would be a major commitment of resources, says Robert Lande, a law professor at the University of Baltimore who specializes in antitrust cases. A host of other international regulators could also open their books on this deal.

Microsoft's bid is not necessarily an all-or-nothing transaction. It could choose (or be forced) to divest some assets if the merger is approved. Second, if the Justice Department is to scrutinize the deal, it will likely proceed quickly, as its officials could be replaced when a new president takes office next January. Having blessed Google's (nasdaq: GOOG - news - people ) $3.1 billion acquisition of online advertiser DoubleClick over Microsoft's objections, it may also be hard for U.S. regulators to justify a challenge to Microsoft-Yahoo!. Late last year, the European Commission launched an in-depth investigation into that deal.

Key to the Commission's probe of a Yahoo! bid will be the online ad market, which Google also dominates along with search. In addition, it charges higher prices for its ads than Yahoo! and MSN Windows Live, in part because, being so large, there are so many advertisers bidding for space.

"Advertising is often the hidden element in whether a deal is problematic or not," said one European antitrust lawyer who wished to remain anonymous, adding that when European television companies started merging many years ago, the regulatory big concern was about what that would do to competition in the advertising market.

For the last year, Microsoft has repeatedly suffered a loss on its Internet business. During the last quarter of 2007, the company took a loss of $245 million on $863 in revenues for its “online services” segment. Although Yahoo’s revenue grew by 7% in 2007, $6.9 billion up from $6.4 billion in 2006, it took a 23% nosedive on its net income in the fourth quarter of last year. By contrast, Google’s revenue for the last quarter increase 51%, to $4.83 billion from $3.21 billion during the same period in 2006.

With Yahoo! ailing, the only tech company with enough capital to go head-to-head with Google is Microsoft, and bulking up its weak Internet business might be just the way to do it.

One other thing Microsoft has on its side: Chief Executive Steve Ballmer's experience with regulators. After more than a decade of dealing with them, expect he's learned a thing or two about getting what he wants.