In 2006, Yahoo! had net income of $751M on revenues of $6.4B, for a margin of 11% (in 2005 it boasted margins of 36% though) with a P/E of 60.  Google, meanwhile, did $3B in net income on $10.6B in revenues, for a margin of 29%, with a P/E of 46.

So say on average, a top tier US portal boasts margins of 25% and a P/E of 50 (quite rich, I know), that implies that MSN.com / Live Search

- generates profits of 0.25 x $2.3B = $575M
- is worth $28.75B

At today’s close, Yahoo! was worth $43B and Google a stunning $144B. 

At a valuation of $28.75B, MSN.com / Live Search would be worth 67% of Yahoo! and 20% of Google.

Of course, Google owns 5% of AOL.com… and while many have talked about AOL.com being bought by Yahoo!, and many are calling for MSFT to outright buy Yahoo!, I am thinking, why not spin off MSN.com / Live Search into Yahoo!

Yahoo! has a stronger brand than MSN.com / Live Search (and which one is it, anyway: MSN.com or Live.com?), and frankly, Google’s 50% market share in search implies that it cannot buy a search player without raising the ire of the antitrust cops…

But MSN and Yahoo! combined outside of MSFT, now that could work.  Of course, there is nothing stopping MSFT in being a major shareholder of Yahoo!  If Yahoo! is worth $42B and MSN.com / Live Search would be worth $28.75B, and assume the new entity would be simply worth the sum, which is $71.75B, then technically MSFT could/would own 40% of Yahoo! which is, well, not as crazy as MSFT owning all of Yahoo!

In fact, while 2007 has seen tides turn and the Web gods smile down upon Yahoo! while Google has tripped up with lawsuits and what not, MSN.com / Live Search is not as fortunate as Yahoo!, meaning that it might have an incentive to divest directly in Web ventures to invest indirectly via a spin-off of MSN.com / Live Search into Yahoo!, who has the Web at its DNA core.

The combined entity would be powerful in many ways: its share of searches (according to comScore) would be Yahoo!’s 28.1% + MSFT’s 10.5% = 38.6%, compared to Google’s 48.1%.  More importantly, the combined entity would be far and away the largest media property online, eclipsing everyone else by a mile and reach practically every single Web user in the world.

The likelihood of this is close to zero, and if we could dole out negative percentages, we would here.  MSFT and Bill Gates were slow to recognize the Web’s importance.  They were then slow to embrace search.  With $44B in revenues and 70,000 employees, there is a much higher likelihood for them to double up on search and the Web… but that being said, owning 40% of the world’s largest and arguably greatest media empire would not necessarily be a poor alternative either, and it just might unleash MSN.com/Live’s value.

More strategically, it would also put Google on the defensive, something that MSFT might welcome more than you and I can imagine.

Disclosure: I own shares in YHOO!