As previously reported by CNET's NEWS.COM, Microsoft had been in talks to invest in Hotmail, and sources predicted that a deal might be sealed by year's end. The stock deal for the two-year-old company has been estimated in the hundreds of million of dollars, according to industry sources. Microsoft and Hotmail officials would not comment on the price.

"This [acquisition] completes our lineup," said Laura Jennings, vice president of the Microsoft Network. "We were missing a search engine and free email on MSN until last summer. So we did a deal with Inktomi for search [capabilities] and Hotmail is head and shoulders above the others in terms of scalability of service and members."

During the next few months, Hotmail will be integrated into sites on the Microsoft Network, such as MSN.com, travel site Expedia, and car-buying site CarPoint. Microsoft's idea is to drive traffic to its revenue-generating sites, such as Expedia and CarPoint, and then keep surfers within the Microsoft circle.

The move will create a red carpet ushering in Hotmail's 9 million members to these various sites, where they can log on to retrieve and send email--and hopefully do some shopping while they're there. Microsoft expects that Hotmail will generate more traffic at those popular sites, and that the traffic, in turn, will generate more advertising revenue.

The potential for so many new eyeballs on the site poses a major threat to MSN.com's main rival, online giant America Online. AOL recently announced that it will offer its 10 million members access to their email without logging on to the ISP's network. It also is about to acquire CompuServe, which earlier this week launched a Web-only service, dubbed "C."

USA.Net, a free email provider and Hotmail competitor, said it has little concern about Microsoft moving into its market because USA.Net offers different features than Hotmail.

"The Microsoft acquisition of Hotmail is another great validation that Web-based email is here to stay," said Scott Chasin, USA.Net's chief technology officer. "Things will get very exciting in the coming year, as everyone is looking for a dance partner."

With this deal, MSN, which stopped releasing subscriber numbers in October when membership hovered at 2.3 million, could boost its traffic substantially, driving a potential 9 million Hotmail members to its collective sites. If the strategy holds together MSN could gain a rival number of eyeballs almost overnight, at least in theory.

Microsoft also said it plans to use Hotmail to allow MSN members to access their email through the Web, just as AOL will do.

The move could prove to be a boon when Microsoft describes its numbers to advertisers.

Free email on the MSN.com site is coming at a time when Microsoft is moving more content from behind its firewall on its premium paid service to the open Web site accessible by all. Also, as reported earlier this week, the Microsoft Network has added pull-down menus to several of its sites that link to all its Web properties in an effort to create what in industry parlance is called "synergy."

Financial terms of the deal, other than the fact that it was a stock-swap transaction, were not disclosed, but one industry executive speculated that the value of the deal was as high as $400 million.

That purchase price may seem high, but Hotmail is the dominant player in the free email service space and has a sizable lead over competitor Four11 in membership and brand-name recognition.

Yahoo announced in October it would acquire Four11 in a stock deal valued at $92 million. In addition, Qualcomm's Eudora division announced that it, too, planned to offer free email.

"WhoWhere's partnership with Eudora and Excite, Yahoo's acquisition of Four11, and now Microsoft's acquisition of Hotmail clearly defines the future of electronic mail," said Ted Shelton, senior vice president of sales and marketing for WhoWhere.

This latest MSN-Hotmail deal illustrates the degree to which the line between online services and search directories is blurring. The additional of features such as free Web-based email make them all the more alike.

Microsoft's other recent Internet acquisitions have spanned from a $425 million buyout of WebTV in August to the purchase of streaming video company VXtreme, as well as other investments in the streaming media software industry. The Justice Department, for one, has asked Microsoft for information on its forays into that area.

The deal with Hotmail has been in the works since the fall.

"We started out talking with Microsoft about jointly offering our free email service to MSN members," said Steve Douty, vice president of sales and marketing for Hotmail. "During the discussions we found there were a lot of similarities in our respective goals and culture, as well as complementary technologies and services. We felt that by working closely together we would be able to give our subscribers better services and the benefit of frequent enhancements."

He added that Hotmail has found, over its brief history, that its members also wanted to receive content, personalized information, and e-commerce when accessing their email. That part of the equation is what Microsoft brings to the table.

The Web-based email service said it will continue its operations in Sunnyvale, California, as a wholly owned subsidiary of Microsoft and will report to MSN's Jennings.

One winner in the free email craze is the venture capital firm of Draper Fisher Jurvetson, which is a financial backer of both Hotmail and Four11.