Microsoft Wins, Yahoo Folds, Google Reigns

Microsoft (MSFT) gave Yahoo (YHOO) bare minimum terms in their new 10-year partnership: a fortified combined search engine off of which it can sell and retain advertising revenues, and a possible exit strategy down the road. Either way, Microsoft wins.

The long-anticipated search and advertising pact announced today did not include the favorable terms — primarily billions in upfront revenue guarantees– expected by disappointed Yahoo investors, who initially drove the company’s stock down 12 percent.

Whether by design or coincidence, Microsoft CEO Steve Ballmer played his cards well over the companies’ tumultuous three-year negotiations. Yahoo initially rejected a $47.5 billion buyout offer from Microsoft in 2008 as well as a proposed search partnership with a $1 billion upfront payout last year — both under the leadership of former CEO Jerry Yang.

By comparison, the pact finally approved by new Yahoo CEO Carol Bartz and Yahoo board members (including five percent activist shareholder Carl Icahn) is modest, complex and unlikely to create meteoric value. It’s almost as if there is another shoe to drop in the Microsoft-Yahoo two-step.

At best, Yahoo will realize $500 million in annual operating profit and is guaranteed only 88 percent of ad sales from its affiliated and owned search business in the first five years. Yahoo will see $275 million in cost savings and $200 million less in capital expenditures annually once the companies’ businesses are fully integrated in about two years. Weak advertising and shaky initiatives will depress 2009 operating cash flow 10 percent and drive down revenues 13 percent, analysts estimate.

In the end, Microsoft appears to have paid much less for what it wanted: a way to catapult its well-regarded new Bing search engine (with a mere three percent share) into second place by merging it with Yahoo’s 20 percent market share. It is the only way Microsoft search could get big fast and the only way Yahoo can bolster its waning fortunes.

By joining forces, Microsoft and Yahoo say they can be a more effective competitor, even though their aggregate affiliated 30 percent search share is less than half that of Google’s (GOOG). Microsoft and Yahoo could grow their gross search revenues, after synergies, an average 6.6 percent annually over the next five years, analysts say.

But there is another way to look at this deal.

Yahoo has abruptly thrown in the towel on its decade-long pursuit of branded search that included investing $160 million to build Panama, the technology it will use to sell advertising across the companies’ merged search platform. Yahoo will receive only 88 percent (instead of 100 percent) of paid search revenues, hoping the balance will be made up from an expanded, improved search base. There is no evidence of the “boatload of money” in this deal that Bartz promises.

Bartz’s rationalizes that Yahoo has become less a portal and more of a content company, which seems to put it on the same migration track as rival AOL (TWX), another diminished Internet brand.

Even if a Microsoft-Yahoo cabal tried to acquire or align with AOL, when it is spun off from Time Warner later this year, the three companies’ combined search share would barely make a dent in Google’s nearly 14 billion domestic searches last month, or which accounted for 65 percent of that market. Still, that won’t keep Google from pressing for antitrust scrutiny, despite having been the one to “power” Yahoo’s searches years ago.

Some of the questions raised by this new search pact are far more intriguing than the details:

(Read these questions and add your own at BNET.)

Disclosure: Author does not directly own media or internet stocks.

Comments

[between the...:]

The problem with today's traders is they want the quick buck over the company not doing the right thing. Cut costs and preserve revenue. That is exactly what Yahoo's CEO did. She can shed the expense of search and get guaranteed revenue. It's basically like someone coming in, renaming my neighborhood, and paying my expenses of living while I keep my salary. Brilliant LONG TERM move.

Jul 30 11:20 AM

[OldNavySailor:]

Carol Bartz clearly deceived shareholders about accepting ANY offer from Microsoft without a capital outlay as part of the deal (a.k.a. "boatload of cash"). She has a responsibility to the investing public to be truthful and she was just the opposite. Her comment about money upfront was not rhetorical, but a statement of fact that ultimately mislead the investment community to purchase shares/call options of Yahoo.

This deception is grounds for a class action suit against her and the board of directors of Yahoo.

Jul 30 01:00 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 01:08 PM