Turns out that Yahoo is now in talks with AOL about merging, while at the same time starting a test to use Google AdSense on their search results. Google of course also happens to serve AOL's search ads and owns 5% of the company. At the same time, Microsoft is talking with News Corp. to jointly bid on Yahoo and potentially combine MSN, Yahoo and MySpace.
This whole situation is pretty crazy. But whichever way things shake out in the end, my opinion is that the winner will be Google:
1) If Yahoo somehow stays independent, they will be forced to do something drastic to improve performance and will likely outsource search ads to Google. Even though Yahoo would keep the bulk of the revenue, Google would benefit from the additional scale and data. Meanwhile Microsoft would be in the same position it is today - lacking ad platform scale and falling further behind Google.
2) If Microsoft buys Yahoo, I believe the regulatory issues will be such a drag on timing and integration issues will be such a drag on performance, that Google will have 1-2 years to further increase their lead on the combined MS/Yahoo. If MS screws up the integration, their problems will be amplified.
3) Yahoo and AOL merging is just a repeat of 1), but with added complexity for Yahoo management. Combining a struggling #2 and #4 is not a recipe for success.
4) Microsoft and News Corp. buying Yahoo and throwing MySpace into the mix is a repeat of 2), but with added complexity for Microsoft management. News Corp. would own a small but significant percentage of the new entity and would have a say in how things are run. Bad news all around, except for Google.
Honestly, Google can't lose. They end up serving ads for Yahoo or Yahoo/AOL (which is great for them) or they watch MS/Yahoo or MS/Yahoo/MySpace struggle with integration for a couple of years (great for them) or they deal with the status quo (which has been great for them). In the meantime they will throw as many wrenches as they can into the process, creating more uncertainty for everyone else and increasing their lead.
Macro issues notwithstanding, Google stock will be much higher (especially compared to YHOO and MSFT) over the next 2-3 years.