The share market reaction says it all about Microsoft’s $US45 billion cash and shares offer for Yahoo.

Microsoft shares had their worst fall in 21 months as they tumbled $US2.15 (6.6%) to $US30.45 on Friday night in New York. And joyful investors pushed Yahoo shares $US9.20, or 48% higher, Yahoo shares were up 56% until the US Justice Department said it would examine the deal.

Commentators said it was all about poor, tired Microsoft trying to get some internet cred by buying a company whose business strategy had been shredded by Google. Which is a bit like the lame buying the infirm, especially after Yahoo revealed below average earnings, a gloomy outlook for 2008 and cut around 1,000 jobs last week.

Microsoft’s opportunistic attempt to “hug” Yahoo will test a couple of things.

It will test the ability of the US hedge fund industry to bounce back at a time when it is contracting because of the credit crunch and a rising number of dud investments, such as subprime mortgages and associated securities.

It will also test the certainty in the market that the US is now in a bear phase and that this is merely a cashed-up, slow-moving giant taking advantage of problems with a more nimble and desirable competitor in an effort to catch up to the real goal, Google.

Supporters of the idea that the bid will re-ignite takeover activity on Wall Street should remember a very salient point: Google dropped 8% drop on Friday and that wiped $US15 billion off the search giant’s market capitalisation and puts the stock back at September 2007 levels.

Google stock has now dropped more than 230 points from its November high of $US747 a share – wiping out more than $US72 billion in market value. That’s more than half again as much as Microsoft is offering for Yahoo for instance.

Google-owned sites last year became the most visited on the internet, with 587 million people logging in during December. Microsoft, which was ahead a year ago, was visited by 540 million unique users and Yahoo!, in third place globally, had 485 million visitors.

Internet advertising is soaring: Microsoft said it would double from $40 billion now to be worth $80 billion in 2010.

Although Microsoft has long dominated the supply of software for personal computers, it’s ability to replicate on the internet has been a complete failure. Microsoft admitted as much with its bid for Yahoo that MSN and its sites lose money. Even after the price drop since November, Google is now valued at $US162 billion.

In Australia, though, there’s a major problem that might force the deal to be recast. Microsoft has 50% of Ninemsn, the first or second most visited internet site. Yahoo is in a joint venture with the Seven Network with Yahoo7, the ninth most visited site.

The Seven board decided late last year that with the TV and magazines business going very well, the focus this year would be making Yahoo7 pay.

A senior executive, Rohan Lund, has been made CEO of Yahoo7 (he is the Seven Network’s head of all things digital) with the brief to shake it up and turn it into a paying business.

It is around a year, perhaps 18 months behind schedule and the network wants the visibility, the revenue, the number of visitors and the earnings to be significantly improved this year. But there’s doubt this will happen if Microsoft takes control of Yahoo. It will have no interest in boosting a business in competition with the longer established Ninemsn where PBL Media and Microsoft renewed their deal (very expensively, thanks to James Packer) in 2007.

Seven says it has a long term agreement with Yahoo. If Microsoft wins Yahoo, something will have to give.