Microsoft has offered to buy Yahoo for around $44.6 billion in cash and shares, to better compete with Google in the market for online services.
CEO Steve Ballmer made the offer in a letter to Yahoo's board of directors on Thursday, telling the board that he would release the letter Friday morning.
On a conference call Friday, Kevin Johnson, president of Microsoft's Platforms & Services Division, called a combination of Microsoft and Yahoo a more "credible" alternative to Google in the online advertising and services market.
"By combining the assets of Microsoft and Yahoo, we can offer a more competitive choice for consumers, advertisers, and publishers," he said.
It was Yahoo's board that first approached Microsoft, in February 2007, Microsoft said.
Yahoo, in a statement, said its board will carefully evaluate Microsoft's proposal, which it described as unsolicited.
Microsoft expects the market for online advertising to almost double in size over the next three years, from $40 billion in 2007 to $80 billion by 2010. A merger will allow it to realize economies of scale and reduce capital costs as it addresses this market, it said.
Microsoft expects to cut costs by $1 billion a year by realizing synergies with Yahoo in four areas: obtaining economies of scale as its audience increases; combining its research and development efforts with Yahoo's to innovate faster; eliminating operational redundancy to cut costs; and pooling expertise to innovate in video and mobile.
The companies will work together to develop the merger plan, Microsoft said. It intends to pay key Yahoo engineers and other staff to stay following the merger.
The offer represents a 62 percent premium over Yahoo's closing price on Thursday. Microsoft expects to receive all necessary approvals in the second half of this year.
Despite the potential for short-term gain, Yahoo, in its statement, said its goal will be to maximize long-term value for shareholders.
At this premium, even if Yahoo's top managers were opposed to the acquisition, Yahoo's board of directors has an obligation to consider the offer on behalf of shareholders, said industry analyst Greg Sterling from Sterling Market Intelligence.
At the same time, now that Microsoft has made its move, it wouldn't be surprising to see other suitors jump in and make competing bids for Yahoo, Sterling said.
Unless Microsoft were to run Yahoo like an independent unit, there will be significant areas of overlap that would need to be integrated.
"If Microsoft were to seek a more integrated company [with Yahoo], certain products or brands would be favored and others discontinued," Sterling said.
Still, a joint Microsoft-Yahoo would from day one be a formidable player in display advertising and mobile Internet services, he said.