Tim O’Reilly views Microsoft-Yahoo as a Web 2.0 play with the combined company dominating free (Web 1.0) online e-mail services. In a great post generating lots of buzz, he cites Hitwise data showing Yahoo Mail / Yahoo! Address Book at 58 percent of market share (#1) and Windows Live Mail (#2) at 25.5 percent share (not including AOL).

Tim argues the combined personal and private data from e-mail applications would clear the way for developers to create more powerful Web 2.0 apps and an Open ID system. True. Data assets built on networks can be monetized.

Web 2.0, though, has largely been sustained by next-gen “made-for-adsense” online ad-supported business models, developer sweat equity, and the promise of a Google/Yahoo/Microsoft acquisition exit strategy.

O’Reilly thinks Microsoft would be making a “fatal mistake” to take the battle to Google on its own ground. “That’s the very mistake that companies like Netscape made in competing with Microsoft,” he notes. I disagree that lessons from the early browser search engine wargames apply in the age of cloud computing.

The primary problem with a pre-Bubble 1.0 Netscape world view: in online advertising, Yahoo properties successfully compete with Google. Hitwise and comScore data show a combined Microhoo entity far more popular than Google’s network of sites.

Google’s still trying to find ways to compete with the Yahoo/MSN vertical search engines (Finance, News, Sports, Travel, Auto). Fortune 500 brands love them for search-informed display / video ad campaigns. Only YouTube “branded channels” are starting to make significant inroads for Google in strategic digital marketing campaigns.

In O’Reilly Radar blog comments, the often profane but always brilliant Dave McClure of 500 Hats fame notes Google could then jump in to take AOL off the hands of the company formerly known as AOL Time Warner.

McClure also notes the other problem with the e-mail-centric view of the deal: social search engines like Facebook and LinkedIn already have built-in (crude) e-mail systems. Their online e-mail share isn’t counted in the Hitwise data, as O’Reilly notes.

What O’Reilly and McClure omit: Facebook and LinkedIn already have better user data with extensive demographic profiles of their members who’ve given full opt-in permission and share their IDs openly. That’s the fatal flaw in the e-mail as strategic asset argument.

The Microsoft-Yahoo deal is driven by search, not e-mail assets or their Web 2.0 potential. Ceding the search market to Google creates a GoogleNet that would supplant the Internet as an open marketplace.

If e-mail had such huge strategic value, Microsoft would have bid on Facebook at perhaps one-third the price: the much-scoffed at and oft-times scorned $15 billion valuation based on Microsoft’s current stake in Facebook.

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