Search end near?

  @ibtimes on April 17 2009 7:46 PM

It's been more than a year since Microsoft Corp's unsolicited bid to buy Yahoo Inc ended in tatters and acrimony.

Now the two companies are talking again, with the less contentious agenda of forging an Internet search advertising partnership having replaced the notion of an outright merger.

Analysts say that co-opting Yahoo's search assets represents Microsoft's best hope to turn around its money-losing online business and to challenge Google Inc's (GOOG.O: Quote, Profile, Research, Stock Buzz) dominant and growing share of the U.S. search market.

But handing search over to Microsoft would be fraught with risk for Yahoo, which would cede what is believed to be a profitable and increasingly vital plank in its online business. Search data is increasingly used to custom-tailor display advertisements for Web surfers.

You don't walk away from search unless there's some ridiculously huge number in front of you, said RBC Capital Markets analyst Ross Sandler.

Yahoo Chief Executive Carol Bartz and Microsoft CEO Steve Ballmer recently talked about various partnerships, possibly with Microsoft managing Yahoo's search advertising business and Yahoo handling display ads across Microsoft's websites, according to a source familiar with the situation.

Any deal would have to be sweeter than the one unsuccessfully brokered by activist investor Carl Icahn last July, in the wake of Microsoft's failed $47.5 billion acquisition bid for Yahoo, said RBC's Sandler.

Under Icahn's search-only plan, Microsoft was willing to pay Yahoo a $1 billion upfront fee for Yahoo's search assets, plus $2.3 billion a year in guaranteed revenue for five years.

CRITICAL MASS

Microsoft and Yahoo have each lost 1 percentage point or more of market share in U.S. search queries since the two companies first considered combining in February 2008. Google has widened its lead from 59.2 percent market share in February 2008 to 63.7 percent in March 2009, according to comScore.

There is urgency. I hope they both realize they need to get something done sooner rather than later, said Sid Parakh, an analyst at McAdams Wright Ragen, who has a buy rating on Microsoft. But they are not going to rush into a deal that might not work out long-term.

Market share is key in search-based advertising, say analysts, since many of the small businesses that buy online ads do not have enough money to spread their messages across a smattering of websites with limited audiences.

For that reason, running ads with Google is generally considered a no-brainer. But a combined Microsoft-Yahoo with nearly 30 percent search market share could provide a large enough audience to also be worthwhile.

And because search advertising is based on an auction system, size is doubly important. The more advertisers participate, the more keyword prices tend to be bid higher.

Microsoft may be best-placed to run the combined search business, given its strength in sophisticated software needed to run search engines and its superior organization, said one analyst.

What Yahoo does best is make interesting content to attract users, but they can't do project management very well, said Kim Caughey, an analyst at money manager Fort Pitt Capital Group. Microsoft's very good at software and they are a little more structured.

ANTITRUST ATTENTION?

Such an arrangement might put both companies' display ad business under the control of Yahoo, which is the U.S. No. 1 in that market. In February, Yahoo led the market with 13 percent of display ad views. Microsoft was fifth with 4.3 percent and Google sixth with 1.2 percent, according to comScore figures.

That is likely to attract the attention of antitrust regulators, who thwarted a proposed advertising pact between Google and Yahoo last year. But antitrust experts say the market for online display ads is still relatively open, and regulators' main concern is Google's dominance in search.

From a pure antitrust standpoint, it's hard to see a problem here, said Evan Stewart, an antitrust lawyer with Zuckerman Spaeder LLP. If you're from the (U.S. Justice Department) Antitrust Division, what you really want to have is more effective competitors for Google.

Analysts say any deal would have to guarantee Yahoo's access to users' search data.

Without search, Yahoo looks like AOL, said RBC Capital Markets' Sandler, referring to Time Warner Inc's (TWX.N: Quote, Profile, Research, Stock Buzz) online division, which does not have its own search engine and which has seen its users and revenue erode in recent years.

There are many ideas about how a Microsoft-Yahoo partnership could work. Ironfire Capital's Eric Jackson believes they should create a joint venture where Microsoft transfers its online business and combines it with Yahoo's.

The arrangement, first outlined in a Bank of America Merrill Lynch report, would have Microsoft take a 49 percent stake and give Yahoo 51 percent.

The new venture was projected to have $9 billion in net revenue in 2010 versus Google's estimated $16 billion, which would make it a strong No. 2 Internet search player, while boasting the largest Internet display advertising business.

The company would be run by Yahoo, which Jackson said has a better track record in the online business than Microsoft.

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