Yahoo-Microsoft Deal: Long Term Merger Arbitrage?

The market (and internet) is buzzing with talk of the Yahoo!-Microsoft search deal. The deals are pretty simple and somewhat more beneficial than the deal which AOL signed with Google (GOOG) a few years back. Basically, Microsoft (MSFT) will power Yahoo’s (YHOO) search and Yahoo will become the ad platform across both search properties. Yahoo is granting Microsoft a 10-year license on its search technologies and transferring much of their search development team to Microsoft. What becomes of Microsoft AdCenter seems hazy, but without access to a legitimate search destination, it will likely be phased out as advertisers prefer to deal with ad networks that have broader reach.

Implications for Yahoo!
Yahoo is finally embracing the fact that it is not a true tech firm or development shop. The company started as a web directory when the internet was in its nascence. It’s only innovation was that prior to Yahoo, no one had created a comprehensive listing of interesting sites online. Dave Filo was just skilled enough to develop a file server which could scale the website as it became popular and then what? It expanded into various content verticals – finance, games, e-mail. But, name for me a real innovation that it provided. It’s search was the “best” simply by virtue of having a human-vetted directory to pull from. Once crawlers and search algorithms gained popularity, it fell behind the curve and, in fact, was powered by Inktomi (which Yahoo later acquired and ostensibly turned into its search group) and Google.

The question becomes, can an internet content destination without differentiated tech IP – i.e. search, social networking, etc. – be any more successful than an AOL or some other blog network. Search is the #1 online advertising market. Giving up search, necessarily gives up value in Yahoo’s ad network. As users realize Yahoo is no longer providing the search service, will they migrate to Microsoft’s portals?

It will be interesting to watch how Yahoo’s revenue “sources” change as time progresses. At some point in the future, one could imagine that a plurality of their ad revenue will be Microsoft property-generated. As Yahoo is basically purging its search developers, making a move back will be difficult especially since Microsoft will have a claim on any new technologies developed on top of Yahoo’s IP.

Implications for Microsoft
Apparently, there’s some sort of secret sauce in Yahoo’s search IP that Microsoft believes can help them win the battle with Google over “best search product”. (Most popular conspiracy theory is that they want to go after Google for IP infringement.) But, as Facebook will tell you, a great product does not always make money. Microsoft needs to be able to monetize search and search advertising seems to be the current route of choice (no one would pay for search so I can’t think of any other revenue model, but if you can maybe you can shake up this industry).

In order to monetize effectively, one needs scale. Advertisers want to reach the most people for their ad dollars. Google offers this by virtue of 60% search market share (higher in some localities around the globe) as well as a broad and diverse publisher network (AdSense). Microsoft’s move here seems impatient. Strategically, they seem to be more interested in chipping away at Google than profiting for themselves. Instead of developing and nurturing an in-house ad solution, it’s signing a pricey deal to license Yahoo’s search IP and as well as pay Yahoo a premium to serve ads on its search results. The two companies immediately achieve scale which could win advertisers away from Google, but it’s a disincentive to Microsoft’s in-house Ad Center group. Will it survive this partnership? If at the end of 10-years, Yahoo decides to back away, how will Microsoft effectively monetize its internet properties?

My Wild Speculation
Ultimately, it would seem that this deal is more just the groundwork for a potential acquisition of Yahoo. I’m not sure why Microsoft won’t just do it outright. Does Microsoft intend to continue to run MSN? As far as I’ve read, Yahoo’s ad deal does not cover Microsoft’s content properties. How will Microsoft monetize MSN now that its clear that its own Ad Center will not have reach into a much better trafficked search destination? Does Yahoo have what it takes to truly embrace its place as a media company? Can it provide investors the returns that it expects simply through content and advertising? Both companies are giving up an integral portion of what is the only proven sustainable internet business model – search AND search advertising. It would seem the mutual reliance can only point to one thing – a merger.

Full Disclosure: Long shares of GOOG at the time of writing.

Comments

[coyotebait:]

Two questions:

1. How oversold will YHOO get? $14.00, $12.00, $10.00, or less???

2. How much being overlooked?

The recent revamp of the Yahoo page shows Bartz & Co think they can monetize the indisputable power of YHOO (sticky eyeballs) in a new window of opportunity.

Right or wrong, they see customized news delivery on the NET as the future ---- rather than the futile attempt to compete with GOOG for advertisers on the search platform. ...MSFT has the money to try. Let's make a deal! ...To whatever extent MSFT is successful, it will contribute 88% to YHOO's bottom-line and relieve YHOO of the expenses thereof). Whether or not it's a good deal depends upon how Bartz deploys the benefits of an apparently bad deal.

With the demise of most news"papers" YHOO sees Internet news delivery, on-steroids, as the quickest, most practical, and most profitable way to monetize the power of YHOO's online presence.

On this platform whose time has come, advertisers will be able to target their audiences more accurately than ever before ---- what YouTube, FaceBook, and Twitter, have not yet been able to do, and will likely not be able to do nearly as well as YHOO.

Customized news delivery is the new and promising horizon for a new and more prosperous YHOO. ...MSFT-Bing revenues will finance it, securing an acceptable bottom-line (EARNINGS), as well as securing a solid level of cash flow, for the Bartz strategy to play out over the next 5-years.

Unfortunately most analysts and speculators don't have the bandwidth to understand the sound business strategies that this time-proven Autodesk-trained CEO is putting in place.

JMHO

CHOMPS,

^__^

..

Jul 30 01:15 PM

[coyotebait:]

Two questions:

1. How oversold will YHOO get? $14.00, $12.00, $10.00, or less???

2. How much being overlooked?

The recent revamp of the Yahoo page shows Bartz & Co think they can monetize the indisputable power of YHOO (sticky eyeballs) in a new window of opportunity.

Right or wrong, they see customized news delivery on the NET as the future ---- rather than the futile attempt to compete with GOOG for advertisers on the search platform. ...MSFT has the money to try. Let's make a deal! ...To whatever extent MSFT is successful, it will contribute 88% to YHOO's bottom-line and relieve YHOO of the expenses thereof). Whether or not it's a good deal depends upon how Bartz deploys the benefits of an apparently bad deal.

With the demise of most news"papers" YHOO sees Internet news delivery, on-steroids, as the quickest, most practical, and most profitable way to monetize the power of YHOO's online presence.

On this platform whose time has come, advertisers will be able to target their audiences more accurately than ever before ---- what YouTube, FaceBook, and Twitter, have not yet been able to do, and will likely not be able to do nearly as well as YHOO.

Customized news delivery is the new and promising horizon for a new and more prosperous YHOO. ...MSFT-Bing revenues will finance it, securing an acceptable bottom-line (EARNINGS), as well as securing a solid level of cash flow, for the Bartz strategy to play out over the next 5-years.

Unfortunately most analysts and speculators don't have the bandwidth to understand the sound business strategies that this time-proven Autodesk-trained CEO is putting in place.

JMHO

CHOMPS,

^__^

..

Jul 30 02:28 PM

[achates:]

The rest of the piece is, I think, just wrong on a bunch of points, but "Yahoo is finally embracing the fact that it is not a true tech firm or development shop." shows utterly no awareness of the level of technology involved in building and running a property on the scale of Yahoo!

Jul 30 05:13 PM

[The Curious...:]

I'm aware that Yahoo's scale and technology is impressive. My argument that they aren't a true tech firm/development house is that they don't drive value through their tech offerings. It's somewhat similar to why I believe Apple is much more a high-end consumer products play than a tech play. That being said, Apple has shown an ability to combine technological innovation with their consumer facing services - i.e. the iPhone OS platform which is in fact a technological feat.

Yahoo, on the other hand, has not succeeded to this regard - particularly in search. For all the IP that it owns and all the innovations it's trying to push with BOSS, it's search offering as well as its contextual advertising system still lags its competitors by a noticeable degree. It took GMail to push Yahoo to update its mail system and even the recent upgrade has been more front-end than backend. Google has introduced conversation threading, filters, starring, etc. Yahoo's new search, apart from featuring some slick AJAX, behaves as any other run of the mill e-mail client.

Head-to-head comparisons aside, I think we can all agree that Yahoo's real value lies in its "eyeballs." It's status as maybe the only remaining, successful web portal (unless you count AOL...) as well as its ability to drive traffic within its content network. That's why I see them as a media play and it would seem that's what Carol Bartz believes as well given that she's willing to license away Yahoo's most precious tech assets - search.


On Jul 30 05:13 PM achates wrote:

> The rest of the piece is, I think, just wrong on a bunch of points,
> but "Yahoo is finally embracing the fact that it is not a true tech
> firm or development shop." shows utterly no awareness of the level
> of technology involved in building and running a property on the
> scale of Yahoo!

Jul 31 10:28 AM