Yahoo's Waiting Game

Only time will tell whether Yahoo Inc. (NASDAQ:YHOO) made the right decision in inking its paid search deal with Microsoft Corp. (NASDAQ:MSFT). Investors certainly didn't like it, despite Bernstein Research analyst Jeffrey Lindsay's belief in the long-term possibility of the deal adding up to $4 per share in value to Yahoo.

Lindsay wrote in a research note Monday:

The Yahoo-Microsoft paid search agreement is a reasonably good deal for Yahoo shareholders -- but that is rather like valuing a Picasso on the value of the canvas and the paint. Investors are still upset that a unique asset of pivotal strategic importance to the Internet sector was sold off at what they perceive was a knock-down price.

Yahoo shares are likely to stay in "purgatory" and under pressure while the annoyed investor base is replaced by one that likes the longer term promise of Yahoo, he said. This will likely cause the stock to miss out on an expected improvement in display advertising in 2010.

Lindsay, who notes that Yahoo shares are down 17% from their pre-Microsoft deal price (they climbed about 2% in morning trading Monday), said that the deal's revenue stream for Yahoo is far less advantageous than earlier iterations of the agreement, which carried far more explicit revenue guarantees. It's also a complex deal that will require a tricky integration.

"Yahoo is responsible for paid search sales and Microsoft manages the technology -- a classic recipe for misalignment of incentive and mutual finger-pointing," Lindsay writes.

Then there's the missing "boatloads of cash," CEO Carol Bartz's now infamous requirement that any search deal with Microsoft carry a big up-front cash payment, which some observers predicted to be as large as $5 billion. The lack of this initial chunk of money in the agreement was a major factor in pushing Yahoo shares down, and now Bartz has admitted it was a mistake.

"I made a mistake. I was never interested in doing it for upfront money. That doesn't help me operate a business," she told The New York Times. The comment represents a start in moving towards clearing the air and trying to prove the strategic rationale behind the deal (although we probably won't see much in the way of results for a couple years).

Yet Bartz also felt compelled to say "we haven't eviscerated the company" by handing search to Microsoft, making it sound like she could still be on the defensive for some time in explaining the complicated deal -- exactly where a CEO embarking on a major strategic shift doesn't want to be. - Olaf de Senerpont Domis