Microsoft buying Yahoo makes less sense than ever

Now that we've seen the quarterly results and forecast from both Yahoo and Microsoft, Steve Ballmer's $43 billion offer for Yahoo makes less sense than ever.

Yes, Microsoft needs something besides shrink-wrapped software to generate the kind of revenue growth that will excite his shareholders and employees.

Vista has been a disappointment, so much so that it will probably be remembered for helping accelerate  the trend toward more companies adopting on-demand software.

So Ballmer needs to do something. 

But if buying Yahoo in its current form is his only answer, it's not one that investors are impressed with.

My guess is that Microsoft shares would have fallen even more in the wake of its earnings if some investors weren't betting that Ballmer will back away from the Yahoo deal.

That would be hard to do given how much he's been pushing it -- but it's exactly the negotiating position he should take.

If he does, Yahoo shares are likely to plummet back to where they were before this saga started. That could make Yahoo more interesting to other potential partners, like News Corp., which has rumored to want to sell MySpace to Yahoo. 

But it's a chance Ballmer should take.

From the beginning, we've been saying that acquiring Yahoo doesn't solve Microsoft's problem of how to start chipping away at Google's lead in search advertising. Click here and scroll down to see all of our Yahoo-Microsoft coverage.

Given Yahoo's tepid forecast, and its flirtation with outsourcing some of its search business to Google, that argument is off the table.

And the fact that Yahoo just this week said it would open up its platform to developers shows how late the company has been to a huge online trend. Where might Yahoo be if it had spent all that Project Panama money on social networking instead? 

The only way this deal makes sense for Microsoft is if they can combine their entertainment unit with Yahoo's media content to create an online platform for delivering news and entertainment.

The unit that sells the Xbox saw its sales leap by two-thirds in the first quarter, and it turned a profit, reversing a loss from a year ago.  That division is home to Microsoft's best Internet platform to date -- Xbox Live.

Plugging Yahoo's massive amount of content into the Xbox, and combining it with MSN, could help Microsoft attack existing media giants like News Corp. in the market for targeted, behavioral-based brand advertising. That's where the big money is yet to be made in online advertising.

But integrating two disparate cultures would be a massive challenge. 

If Ballmer is serious about that effort, and wants to create value for shareholders, he should think about spinning off its entertainment  and Internet properties into another unit, which look like less and less of a fit in a slow-growing enterprise software company. 

And for the $43 billion he wants to spend on Yahoo, he could pick up Facebook and a bunch of other Internet properties that would be easier to integrate.