Yahoo's Options: Selling Search to Microsoft on the Table Again

Since it looks increasingly unlikely that the search partnership between Google Inc. (GOOG) and Yahoo Inc. (YHOO) will pass a Department of Justice review in its current form, the prospect of Yahoo selling its search business to Microsoft Corp. (MSFT) is again gaining some traction.

It could be a viable option given that search is looking like a losing battle for Yahoo, according to J.P. Morgan analyst Imran Khan. While recent quarters have shown some strong search growth rates, he told clients that this is unsustainable and may reverse itself with continued market share losses. Yahoo is also reportedly in talks with Time Warner Inc.'s (TWX) AOL unit.

So with the threat of further declines in market share reversing some of Yahoo’s monetization gains, fully outsourcing its search operations make strategic sense, the analyst said. “We think Yahoo’s increased investment in search, has come at the expense of display investment, and has given competitors the opportunity to eat away some of Yahoo’s leading display ad market share.”

The solution: focus on gaining user loyalty by boosting its strength in niche categories since the online market continues to fragment. J.P. Morgan estimates that Yahoo could get roughly US$725-million in additional operating cash flow via a search deal with Microsoft. Meanwhile, outsourcing search could produce an estimated US$1.4-billion in cost savings – more than enough to offset associated revenue losses from such a deal.

“Yahoo would be more focused and nimble,” Mr. Khan said. “Without its search business, Yahoo would be very clearly positioned as a content and display advertising entity, thereby clarifying and defining its purpose to advertisers and users.”

A billion-dollar cash infusion would also allow it to buy back stock at depressed prices or make strategic acquisitions.