Microsoft’s $44.6 billion bid for Yahoo! is a bold move; it’s the biggest technology takeover ever contemplated. There’s little doubt that it will go through, no matter how the Yahoo executive board reacts, because Yahoo! has no in-built defense against a predatory bid and Microsoft is offering a 62% premium on yesterday’s share price. The share holders will vote for it, I’m sure.

So the question is:

How well will Microsoft be able to digest Yahoo!?

Judith Hurwitz and I had a fairly long conversation about this and we’re blogging it almost simultaneously, (Click here to read Judith’s Blog). Much of what follows is an elaboration of that conversation:

Microsoft’s previous largest acquisition was aQuantive (for $6 billion) about 8 months ago, which resulted in aQuantive’s CEO Brian McAndrews being put in charge of a new Microsoft business group; the Advertiser and Publisher Solutions group. aQuantive was the Internet advertising company that Microsoft snatched up in the wake of Google’s acquisition of Double-Click. Microsoft paid a premium for aQuantive too, an 85% premium.

Microsoft doesn’t normally do large acquisitions, it impossible to know whether it has a talent for making them work. Maybe so, maybe not.

If you add the aQuantive acquisition to the Yahoo! acquisition, then Microsoft just got to be one of the only two giant advertising platforms on the Internet – for a price of $50 billion. The Internet advertising market itself only generates $40 billion per year.

But that’s how serious Microsoft takes Google as a competitor. Having failed to compete using just its technology assets, it’s now trying to buy its way into a competitive position. The challenges that Microsoft faces with the Yahoo! acquisition are:

1. Yahoo! was in decline and so was Microsoft’s Internet business. Microsoft doesn’t just have to integrate them both, it also has to remove the cause of failure from both. Does it know why both companies continue to lose to Google?
2. Integrating Yahoo! will take years. There are overlapping capabilities; search, advertising, free email, news reporting, maps and so on. The positive side of this is the opportunity to save costs, but integrating these capabilities without losing traffic will be difficult.
3. As an ISP Yahoo! has a completely different technology base. It uses FreeBSD, Apache, PHP and MySQL for most of its operations. (The inventor of PHP actually works for Yahoo!) It’s pretty much a not-invented-in-Redmond company.
4. And that means there will be a cultural clash to overcome. This will take place at many levels.
5. Yahoo! has no big technology contribution to make to Microsoft. One of Google’s business advantages is its server farm technology, which it builds in-house. It delivers best-in-the-industry price performance for all Google’s operations. Yahoo! has no equivalent. The technology problem still needs to be solved.
6. Yahoo! delivers Microsoft an increased share of the search market (according to December 2007 figures from comScore, Yahoo! has 23%, Microsoft has 10% and Google has 58%). Put Yahoo! together with Microsoft and you still don’t get into striking distance of Google. Something else is required to catch up with Google.
7. What will Microsoft do with the Yahoo! brand?

The last challenge may be the greatest challenge of all (Judith Hurwitz clearly thinks so). If Microsoft simply rebrands everything as Microsoft Live or even rebrands under Microsoft colors, it will lose traffic. I have no doubt of that. My personal opinion is that it would be far better to move in the opposite direction and put the Microsoft Internet assets under the Yahoo! brand. Bu t I think Microsoft would find that hard to do.

In response to the news, Yahoo! shares shot up 45%, Microsoft shares fell 6.2% and Google dropped 9.5%. Clearly the market believes this is bad news for Google. I think that it’s far too early to tell.