Microsoft Feeds Cash to Online Services Business

With the possibility of a Yahoo acquisition still uncertain, Microsoft is pouring hundreds of millions of additional investment dollars into its Online Services Business (OSB) in an aggressive effort to compete with Google in online advertising.

On a conference call Thursday to report its fiscal 2008 earnings, Microsoft Chief Financial Officer Chris Liddell said the company is investing the money in its online properties to drive advertising revenue and improve the performance and reach of its search engine and advertising network.

Microsoft's OSB is its weakest-performing division next to its Entertainment and Devices Division which -- despite the popularity of the Xbox product -- like OSB does not operate profitably.

Microsoft posted more than US$60 billion in revenue for fiscal 2008, and even OSB showed a revenue gain of 32 percent, from $2.44 billion in 2007 to $3.21 billion in fiscal 2008.

For the year, however, OSB lost $1.23 billion in operating income; a nearly 100 percent increase over the $617 million loss in operating income in fiscal 2007.

Liddell noted that Microsoft understands the weight of investing heavily in OSB if the company doesn't reap return on that investment, especially in light of the segment's lackluster results over the years.

"We do not make these investments lightly, as the loss in this division will be a drag on an otherwise exceptionally good performance," he said.

Liddell acknowledged that had Microsoft managed to seal the deal with Yahoo during the 2008 fiscal year, which ended June 30, it would have "accelerated" Microsoft's goals for improving OSB's performance and its search business in particular, and perhaps the investments would not have been necessary.

However, when it became clear the deal would not happen in the short term, Microsoft "made some decisions to accelerate our online services' organic growth strategy," he said.

Specifically, the investments will be made in several areas of the online business, with two-thirds of the money going into Microsoft's search assets, Liddell said.

One area of focus on search will be to drive usage of its search engine, as well as "business-model innovation, specifically in the area of high-value commercial search," Liddell said.

He cited Microsoft's Cashback program as an example of the latter. Launched in May, Cashback is comparative shopping feature in Microsoft's Live Search that offers consumers rebates on purchases of products found through the search engine. It's aimed at luring consumers away from Google and Yahoo.

Microsoft also will seek distribution partnerships to bolster online advertising and will consolidate display and search advertising into a single ad system for publishers and advertisers, Liddell said.

Microsoft also plans to invest in its adCenter advertising platform by making "small acquisitions" to improve the technology of the platform, as well as signing up new partners to increase its number of advertisers and the amount of "high-quality inventory" available to them, he said.

The rest of the money will go into Microsoft's communication and social-networking strategies, as well as a plan to provide more entertainment content via the MSN portal, Liddell added.

Even as it's pouring its own money into its search business, there is still a chance Microsoft will eventually acquire Yahoo or at least its search assets at some point.

As of Friday, however, the companies remained locked in a public war of words over a proxy battle led by Carl Icahn, who recently teamed up with Microsoft to offer Yahoo a proposal to purchase only its search business. Yahoo rejected that proposal last Saturday, even though Microsoft claimed it was Yahoo Chairman Roy Bostock's idea to do such a deal.

Yahoo on Friday did win an ally against Icahn, who aims to remove the current Yahoo board at a shareholder meeting next month. Legg Mason, one of the largest holders of Yahoo stock, said it will back the company's recommendations for its board of directors instead of those offered by Icahn.

There are also rumors that Microsoft is in talks with Time Warner to buy AOL to bolster Microsoft's online business. However, while a deal with AOL would be less culturally and politically inflammatory and possibly easier for Microsoft to negotiate, the company would not win the valuable search assets of Yahoo.