How could that be? Because by swallowing up Yahoo, Microsoft will be removing one of the biggest and most active acquirors of start-ups in Silicon Valley. The intense competition between Microsoft, Google, and Yahoo has arguably been one of the main factors helping drive up M&A activity and prices for internet related start-ups. It seems like every rumored acquisition over the past few years has had all three fighting in some way to win the deal.
Even though Yahoo has been wounded of late, it still had a market cap in the 10's of billions of dollars which allowed it to be a legitimate competitor for any deal under $1BN and in fact Yahoo has been a pretty active player in that market whether its del.icio.us, flickr, Rivals, etc.
If it's acquired by Microsoft, that will leave only two Internet media/search acquirors with the ability to easily do sub $1BN deals. What's more, while Microsoft has recently show a willingness to deal really big deals such as Acquantive and now Yahoo, it has traditionally been less willing to smaller "tuck in" deals, deals that Yahoo has traditionally been much more active in. Indeed, Microsoft has traditionally been dismissive of these deals because they just don't move the needle for them and their engineering staffs still retain a relatively high degree of NIH attitude.
Losing one of the Valley's most reliable "tuck in" acquirors and second place bidders is a net negative for the Valley. It will make M&A less competitive in general and will reduce the # of potential exits for "me too" start ups" to 2 instead of three. That's bad news for Internet content/search start-ups and their VC backers anyway you look at it.
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