What's Behind Microsoft's Interest in Facebook?

Yes, Microsoft Corporation (MSFT) blew through its numbers with its fastest growth rate since the 90s. Many have stated that some key facets of its business are eroding, and unsustainable. I am focusing on its attempt to become a major player in online advertising.

For several years now MSFT has been playing, but this year it has thrown its hat in the ring in a bigger way with two equity investments, as online advertising appears to have become a leading strategy.

This is a perfect entrance into how fabulous the Facebook deal is, right? Not so fast.

For Microsoft, the deal is a full admission of how important online advertising will someday be to its top, and bottom line. Without a series of previous blunders, in fact, online ads would already be a major contributor to both its top and bottom lines. With the Facebook deal, and the acquisition of aQuantive, it is time to prove to the street that MSFT can generate revenue, and feed the bottom line. Show me the money!

How hard or easy should this be for MSFT?

This week, BusinessWeek reported that:

The arrangement gives Microsoft control over the placement of banner ads on Facebook outside the U.S., where about 60% of Facebook's 49 million active users reside. Microsoft had already reached agreements to sell U.S. banner ads for Facebook through 2011. "It signals an enormous vote of confidence from our largest advertising partner," Kevin Johnson, president of the Platforms & Services Div. at Microsoft, said during a conference call announcing the investment.

Please note Kevin Johnson’s title, not very online ad focused. Next, if it is time for lunch we know who is eating Microsoft’s, Google Inc. (GOOG).

Google already has a lock on placing ads on the top social networking site MySpace. In a transaction outlined in 2006, Google is in charge of placing search-related ads on MySpace. Google also serves as the main MySpace search engine. Among social networking sites, MySpace received 76% of U.S. traffic in the week ended Oct. 20, compared to 15% for Facebook.

In the end, the deal was more important for Microsoft because the software giant has badly lagged Google in online ad revenue. While Microsoft won the right to serve banner ads overseas, it's unclear what else the company got. Van Natta said the deal didn't include Web search, a business that could prove quite valuable.

What exactly did Microsoft gain? It coughed up $240 million in cash (keeping in mind MFST has $23.4 billion in cash hoarded away) for 1.6% of Facebook, which is hardly a material stake in the firm while creating a valuation for Facebook that is too obscene to print.

MSFT also received the right to sell international remnant banner advertising. Remnant ads are just what the term implies - pieces that fell through cracks after major purchases cherry picked what they wanted. Facebook will be selling the prime space itself. It is important to note that MGST also did not get the search rights, a key part of the business.

So what has MSFT done lately that warrants an investment after the post earnings report afterglow?

Disclosure: Mr. Corn is CEO of Clear Asset Management Inc. Mr. Corn hold no position in Microsoft Corporation (MSFT). Google (GOOG) is a holding in the Clear Large Cap Growth portfolio. Mr. Corn owns shares of (GOOG) directly through his participation in the portfolio.