Microsoft and Yahoo Should Head For the Altar

(MoneyWatch)  The patience over Microsoft and Yahoo's never-ending deal dance is wearing thin among the chattering class?€"bloggers, analysts and folks sick of following this dysfunctional courtship?€"and the consensus is right. The time to do a Microsoft-Yahoo deal is now and it's time to put aside the bad boardroom blood and hook up on search.

For those keeping score at home, Yahoo CEO Jerry Yang said the company is open to a deal with Microsoft in a widely panned keynote. Microsoft CEO Steve Ballmer said Microsoft isn't interested in Yahoo just a few weeks after saying a deal made sense. In the meantime, Google has walked away from a search deal with Yahoo in a move that opens the door for Microsoft's return.

Here's what we know:

• Google is a runaway freight train in search.
• Yahoo is a solid No. 2 but won't remain that way forever.
• Microsoft needs scale if it's going to be a search player. A few analysts note that Microsoft's search technology is improving, but it doesn't have the audience to refine its ad system.

Combine Microsoft and Yahoo search?€"not a full merger just a search partnership?€"and you get the matchup we all know is going to happen: Microsoft vs. Google. There are two alternatives in the search marketplace (monopoly and duopoly). Without a deal between Yahoo and Microsoft we'll get a Google monopoly.

Is a search deal between Yahoo and Microsoft really that complicated? Not at all. In fact, a Microsoft-Yahoo deal would look like any other outsourcing pact. Companies do it with data centers all the time. You sell your assets to the outsourcing firm (basically Microsoft in search) and the service provider rents it back to you. Yahoo would farm out its search to Microsoft, the software giant would guarantee a minimum payment and Yang & Co. would use Redmond's text ads. Big whoop. Is that so hard?

This Microsoft-Yahoo search deal makes so much sense that it's obvious to basically everyone?€"except for Yang and Ballmer.

Jeffries analyst Youseff Squali makes the case simply: Don't hold a grudge, just deal. Squali's points are rather obvious:

• A search deal with Yahoo gives Microsoft what it wants without the other stuff;
• Microsoft gets a search business performing better than its own;
• Yahoo would get a financial boost and execute on its best option. You don't really think a deal with AOL makes sense do you?

Squali writes in a research note:

Just deal. Willingness of Yahoo!'s board to deal, relative resilience of search in these tough economic times, scrutiny from DOJ of Google's dominance and positive advertiser feedback for a deal all bode well for Microsoft. We believe that the timing for a search deal with Yahoo! could not be more fortuitous.

Collins Stewart analyst Sandeep Aggarwal puts a little more detail on a potential deal and likens it to a "sale and leaseback" arrangement that happens in the technology industry all the time.

Aggarwal writes:

Though a possible MSFT/YHOO Search deal may be structured in several different ways, we think that broadly it will be similar to a Google AdSense type of Search deal but delivering exclusivity and long-term visibility to Microsoft. Hence, we expect a "Sale and Leaseback" structure wherein YHOO sells its Search assets (i.e. Search technology, IT data centers, Search related headcount, and advertisers' contracts) to Microsoft. In return Microsoft pays $1bn in an upfront payment for the assets acquisition and deploys its search technology at YHOO (as a private label search provider) with minimum guarantees of $2.5bn+ in annual revenue to YHOO and $700mm in Op-Ex savings.

Aggarwal 's chart tells the tale:

See it's simple. So what are Microsoft and Yahoo waiting for?

Larry Dignan is Editor in Chief of ZDNet and Editorial Director of ZDNet sister site TechRepublic. See his full profile and disclosure of his industry affiliations.
Credit: ZDNet