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Is Microsoft going down the same road as the ill-fated AOL-Time Warner merger with its hostile takeover bid of Yahoo?

Microsoft has offered $44.6 billion in cash and stock to purchase Yahoo, or $31 a share, a 62 percent premium on Yahoo’s closing price on January 31.

Microsoft predicts that the merger would bring about efficiencies that would save around $1 billion annually. As it estimates that the value of online advertising will go up to $80 billion in the next three years, Microsoft is hoping to boost its share of that pie by capturing it together with Yahoo.

On paper, they seem like a good match - the world’s biggest software company hooking up with one of the largest internet media companies.

Both had been leaders in their respective fields but fell short in the online world when they ran up against the 1000-pound gorilla Google, especially Yahoo, as both itself and Microsoft have struggled to match Google’s dominance in capturing the internet search market and online advertising dollars.

The deal is a godsend for Yahoo shareholders.

The company’s shares surged after the news of the takeover offer. Yahoo is currently vulnerable, with its share prices down a third in the past year and recent announcements of slashing 1,000 jobs to cut costs, even as it offered a gloomy outlook for the rest of the year. Its chairman Terry Semel also stepped down in a shakeup, after being deposed of the chief executive position in June.

According to CNBC, Yahoo has over 500 million visitors at its range of media sites including Yahoo Mail, the world’s biggest e-mail service for consumers.

But analysts have justifiably been skeptical of the value of this bid for Microsoft, its most expensive to date.

Even if the deal goes through, many factors still point to the enormity of the work ahead for Microsoft.

For a a start, melding the two different cultures and technologies of both companies will be a huge hurdle for Microsoft.

As a sign of its worry that a brain drain would hemorrhage Yahoo if the deal is successful, Microsoft has tried to overcome the problem by offering generous retention packages to Yahoo engineers, key leaders and employees.

They would also have to sort out how to deal with their similar online services, from instant messaging and email, to news, sports and travel sites. Should they close down the MSN sites in favor of a Yahoo brand, or would there continue to be separate services?

More pertinently, Microsoft is paying a huge premium to be just number two in internet search behind Google and it does not make sense.

Estimates put Google’s share of the worldwide web search market at around 77 percent, while Yahoo is second with 16 percent and Microsoft a distant third with 3.7 percent. Combined, Microsoft-Yahoo would still be a distant second, with just around 20 per cent.

It is hard to see both of them being any more innovative to eat into Google’s dominance by much.

Microsoft-Yahoo would have about 20-24 per cent of the global search advertising market, an analyst at Oppenheimer told the Financial Times. The paper added that Google is estimated to have captured about 70 per cent of search advertising, which accounts for nearly 45 per cent of all online advertising.

Again, it is questionable if Microsoft-Yahoo can come up with new platforms that will steal substantial market share from Google, after Microsoft’s $6 billion purchase of online advertising company aQuantitive last May did not deliver profit to Microsoft’s online services division.

And why is it subjecting the merged entity to the possibility of facing anti-trust scrutiny, not just in the US but likely in Europe too?

The bottom line is, Microsoft and Steve Ballmer are desperate to be a factor on the internet. Despite having spent hundreds of millions to beef up its internet business, Microsoft’s efforts in the area is still not profitable. The FT said that Microsoft’s online services division, while only making up five per cent of Microsoft’s revenues, had been loss-making, to the tune of $510 million in the last half of 2007.

Yahoo’s board and shareholders should be smart enough to take the offer and run as the firm is in decline, but may yet try to extract a few more dollars out of Microsoft.

If the deal finalizes, it would be the largest in the internet market since the $182 billion purchase of Time Warner by AOL in 2001.

We know how that deal turned out. It has often been cited as one of the worst mergers in recent corporate history, as factors such as the incompatible corporate cultures of both companies and predicted synergies that did not occur caused the deal to sour, to the extent that Time Warner is looking to sell AOL.

So good luck Microsoft, looks like you would need it.