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.
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. 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, 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:
- How hard did Yahoo try to secure a $2 billion to $3 billion upfront payment of guaranteed revenue from Microsoft, and why didn't they get it?
- Will the rationale of maintaining separate display ad operations be an effective deterrent to rigorous antitrust review?
- Why has Microsoft grossly underestimated the importance of mobile search by failing to include it in this deal?
- How will two companies that took three years of grueling negotiations to get this far successfully manage the integration and execution risks ahead?
- Is the five-year limit to Yahoo's favored ad revenue split, after which Microsoft could resume its own ad sales, designed to force Yahoo into a full-blown merger?