In its largest acquisition ever, Microsoft plans to pay US$6 billion in cash for online advertising company aQuantive. The acquisition represents a major expansion of Microsoft's advertising efforts—instead of selling advertising only on Microsoft sites and properties, the company will provide services and technology platforms for advertisers and publishers. The acquisition is not only driven by fear of Google, which is building a strong lead in online advertising and gradually encroaching on Microsoft's core software franchises—it's also a clear indication of Microsoft's urgency to build a third major business to augment its maturing desktop and server software businesses.

Microsoft has also taken a minority stake in job-listing site CareerBuilder and extended its partnership with MSN through 2013; acquired ScreenTonic, which develops technology for placing advertisements on mobile phones; and sold Vexcel Canada, a subsidiary of Vexcel, which Microsoft bought in 2006 to provide imagery and technology for its Live Local mapping site.

aQuantive Acquisition

Microsoft has offered to acquire Seattle, WA—based aQuantive for US$66.50 per share—an 85% premium over aQuantive's closing share price on the date before the offer was disclosed. According to Microsoft Chief Financial Officer Chris Liddell, the premium price was necessary because of a "competitive" bidding situation, and is justified because of the spectacular growth projected in the online advertising industry—Microsoft believes total online advertising revenue will be US$40 billion in 2007 and will grow 20% per year through 2010.

The deal was likely spurred in part by Google's US$3.1 billion acquisition of DoubleClick, which has a similar advertising syndication network and tools for advertisers and publishers. The DoubleClick purchase kicked off a flurry of consolidation in the online advertising industry: shortly thereafter, Yahoo paid US$680 million to acquire Right Media (of which it already owned a 20% stake), and advertising and marketing conglomerate WPP Group paid US$649 million to acquire 24/7 Real Media.

AQuantive earned net profits of US$54 million on revenues of US$442 million in 2006, making it one of the most financially successful companies in this sector. By way of comparison, DoubleClick earned US$40 million on US$302 million in revenue in 2004 and has shrunk considerably since then. (Hellman-Friedman, the equity firm that took DoubleClick private in 2005, had already sold two of DoubleClick's business units before selling the remainder of the company to Google this year.) 24/7 Media ran a slight loss in its most recently reported quarter and expected to pull in US$270 million in revenue for 2007.

AQuantive includes three main businesses: an online advertising agency and marketing consultancy, a set of tools for advertisers and online publishers that want to sell advertisements, and a syndication network that helps match advertisers with open inventory.

Advertising Agency

AQuantive was founded in 1997 as Avenue A, an advertising agency that specializes in online media, and in 2004, the company acquired Razorfish, an Internet marketing and consulting company based in New York. The combined business, Avenue A | Razorfish, designs and builds customer-facing Web sites and corporate sites (including intranets, extranets, and training sites), and designs and implements marketing and advertising campaigns (including display advertising, e-mail marketing, and search engine marketing). aQuantive has also acquired other online advertising and marketing firms and incorporated them into a single Digital Marketing Services (DMS) unit. This unit remains at the core of aQuantive's business: in the quarter ending Mar. 31, 2007, the DMS unit contributed US$83.1 million in revenue, or about 58% of the company's total, and had operating profits of US$10.3 million, or about 38% of the company's total.

Apart from its revenue contribution, this unit could help Microsoft promote its recently introduced Silverlight technology, a competitor to Adobe's Flash, which is widely used for interactive advertisements and Web sites today. One of the first demonstrations of Silverlight, a Netflix online movie rental application, was built by Avenue A | Razorfish. In the long run, having an internal advertising agency gives Microsoft a strong communication channel with major advertisers, which could help the company derive new advertising opportunities from emerging products, such as its Internet Protocol TV (IPTV) platform.

However, advertisers may be reluctant to work with an agency that's so closely tied to one of the major sellers of advertising inventory—Microsoft's combined Web sites, including MSN and Windows Live, are consistently in the top three most-visited Web properties, and the main source of revenue for these Web sites is advertising. To mitigate this problem, Microsoft says it will continue to operate Avenue A | Razorfish as an independent business for the time being and might eventually spin it back off into a separate company, although Liddell denied any such plans in a conference call discussing the acquisition.

Tools for Advertisers and Publishers

AQuantive's second business unit, Digital Marketing Technologies (DMT), consists of Atlas, a set of tools for agencies to design and track advertising campaigns and for publishers to manage their digital advertising inventory, and Accipiter, which provides technology for Web sites to serve advertisements. (MSN is a long-time client of Accipiter, which has had several owners.) This business unit constituted 27% of aQuantive's revenue in the most recent quarter but was highly profitable, contributing more than 50% of the company's operating income.

This business will help Microsoft improve its offerings for advertisers, both on Microsoft properties and third-party Web sites. It could also help Microsoft design advertising platforms for IPTV and other products.

Syndication

AQuantive's third business unit is Digital Performance Media (DPM) and consists primarily of two advertising syndication networks: DRIVEpm and MediaBrokers. In general, advertisers use these networks to place commercial messages on third-party sites (publishers in online advertising parlance), with a user-tracking system (usually employing Web browser cookies) to help target the advertisements.

This is aQuantive's smallest business, contributing only 15% of its revenue and 12% of its operating profit. However, it's also the most obvious short-term fit for Microsoft: aQuantive advertisers will be able to reach the massive number of users that visit MSN and related Web sites, while Microsoft will now be able to sell advertisements on third-party sites.

What Happens Next?

Because of the size of the acquisition, it will be subject to regulatory scrutiny in the United States, Germany, and perhaps other countries, according to Microsoft Chief Counsel Brad Smith. On a call discussing the acquisition, Smith said that Microsoft continues to object to Google's acquisition of DoubleClick on antitrust grounds—in that case, Smith says, Google is expanding its presence in a market where it's already dominant, which could give it 80% market share and reduce competition. Smith argued that Microsoft, in contrast, has a relatively small portion of online advertising revenue and is entering some new markets—such as online advertising syndication—with the aQuantive acquisition, which will increase competition in the online advertising market overall.

Outside the transaction costs, the acquisition will not affect Microsoft's financial estimates for FY'08, according to Liddell, although it will have an effect on the projected revenue for Microsoft's Online Services business segment. Microsoft will offer more details about the expected financial impact of the acquisition in its Q4'07 earnings conference call.

Until now, Microsoft's largest acquisition was the US$1.33 billion purchase of Danish business management software company Navision in 2002. Navision joined Great Plains, which Microsoft acquired for US$1.1 billion in 2001, to form the Microsoft Business Solutions business unit, which now sells products under the Dynamics brand name. Microsoft also invested US$5 billion in AT&T in 1999, which has since been transferred to a small minority stake in Comcast.

AQuantive's Web site is www.aquantive.com.

Other Investment Activity

Microsoft's Online Services business segment participated in three other significant business transactions in the first half of May 2007: an investment in job-listing site CareerBuilder, an acquisition of mobile-advertising technology company ScreenTonic, and a divestment of the Canadian subsidiary of imaging technology company Vexcel.

CareerBuilder Stake

Microsoft took a 4% stake in CareerBuilder, the largest job-listing Web site in both users and revenue, for an undisclosed amount. In exchange, CareerBuilder will pay Microsoft up to US$443 million over the next seven years to remain the exclusive provider of job listings on the MSN Careers channel through 2013; the amount of the payment will depend primarily on the number of users MSN Careers drives to CareerBuilder. The other owners of CareerBuilder are newspaper chains Gannett (which owns a 40.8% stake), Tribune (40.8%), and McClatchy (14.4%).

Job listings sites earn money primarily from employers, who pay to post job openings and search for candidates. CareerBuilder garnered US$172 million in revenue in the second quarter of 2006, the last quarter for which it revealed results.

The two companies have a long history: in May 1999, Microsoft invested US$17.8 million for a 6% stake in CareerBuilder, which was publicly traded at that time, and made it the exclusive provider of job listings on MSN. However, after several newspaper chains took CareerBuilder private in 2000, MSN jettisoned the service for its main competitor, Monster.com, in Nov. 2001—only to switch back to an exclusive deal with CareerBuilder in Jan. 2004. CareerBuilder says that this 2004 deal, along with a similar agreement with AOL, nearly doubled its traffic, and today the company leads its field with nearly 21 million monthly users, compared with about 15 million for Monster.com and 11 million for Yahoo's HotJobs site, according to Apr. 2007 figures from ComScore.

CareerBuilder is located at www.careerbuilder.com.

ScreenTonic Acquisition

Microsoft acquired ScreenTonic, a privately held French company that provides technology for displaying advertisements on mobile phones, for an undisclosed amount. Founded in 2001, ScreenTonic works with advertisers and agencies to design campaigns, then uses its STAMP platform to place and track advertisements on mobile Web pages and the mobile portals overseen by carriers, such as France's Orange; the company claims that portals and carriers need minimal technical participation in the process. ScreenTonic delivers more than 80 million advertising impressions per month and counts advertisers such as BMW, Coca-Cola, and Paramount Pictures among its customers. The acquisition will help Microsoft expand its advertising sales to mobile Web sites and services, including mobile versions of Windows Live services.

ScreenTonic's Web site is www.screentonic.com.

Vexcel Canada Divestment

Microsoft sold Vexcel Canada to MacDonald, Dettwiler, and Associates (MDA), a Canadian information services firm, for an undisclosed amount. Vexcel Canada was a subsidiary of Boulder, CO—based Vexcel, which Microsoft acquired in 2006 to provide geospatial information and imaging technology for its Live Local mapping service.

MDA is located at www.mda.ca.