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Google Wins, Yahoo Still Standing


As the dust begins to settle from Yahoo's announcement that it had broken off talks with Microsoft and signed a major ad-outsourcing deal with Google, industry watchers look ahead.

Will it pass muster with regulators?

Through the nonexclusive deal, Yahoo (NASDAQ: YHOO) will be able to run ads from Google (NASDAQ: GOOG) next to its search results and on Web pages throughout its network.

The deal is limited to Yahoo and its partners in the United States and Canada, and the search company expects to bring in up to $450 million in additional cash flow in the first year. Eventually, the company sees the deal as an $800 million opportunity.

Yahoo ranks a distant No. 2 behind Google in its share of the search market. The company has been at the center of an industry-wide maelstrom since Microsoft (NASDAQ: MSFT) announced its bid to acquire the slumping Internet pioneer on Feb. 1.

Microsoft maintained that the acquisition was the only way to create a viable competitor to Google in the search-advertising business. Instead, the fallout from the bid drove Yahoo closer to Google, which might be the clearest winner in this saga.

"Of the three of them, it's hardest to see what they lost in this process," Gartner (NYSE: IT) analyst Andrew Frank told InternetNews.com.

The deal would certainly expand the reach of Google's ad network. At its discretion, Yahoo would place ads from Google's AdSense and AdWords platforms throughout its sites.

Advertisers would pay Google for those ads on a cost-per-click basis, and Google would in turn pay Yahoo.

The companies' instant-messaging clients will also become interoperable.

Google and Yahoo did not disclose the revenue split of the ad deal. They also gave no indication of what portion of Yahoo's search ads might be expected to be outsourced to Google.

Still, Jeffries & Company analyst Youssef Squali estimated it to be 30 percent, which would effectively give Google control of an additional 6 percent of the total search market.

According to the most recent figures from comScore (NASDAQ: SCOR), Yahoo held 20.4 percent of the search engine market, compared with Google's commanding 61.6 percent. Microsoft's share was 9.1 percent.

Monetizing search queries

In addition to its slipping market share, Yahoo also does not monetize search queries as effectively as Google. Yahoo President Sue Decker estimated that Google holds a monetization edge of 60 percent to 70 percent over Yahoo.

Imran Khan, an analyst at JPMorgan Chase (NYSE: JPM), declared Google the winner of this transaction and said the search giant stands to gain $560 million in revenue next year as a result of the deal.

"While making use of Google's paid search-advertising technology directly addresses weaknesses in monetization, it does not address market share loss issues," Khan wrote in a research note.

"Furthermore, we are concerned that some of the affiliate business may decide to work directly with Google rather than with Yahoo," he added.

This ad deal presents real concern for Yahoo, as it could be heading down a slippery slope. Yahoo retains the flexibility to use only the Google ads that it wants, so it will continue to place search ads through its Panama platform.

But given Google's monetization edge, it's easy to imagine the balance of Yahoo's advertising operations gradually tipping away from in-house to outsourced.

That gets at the central issue of Yahoo's long-term market standing.

"Does this solve Yahoo's problem? That's still a significant question," Frank said. "It's pretty clear that there's a trad-eoff here between incremental short-term revenues and long-term value."

But Yahoo had to do something. The company has been under intense pressure from investors, most notably Carl Icahn, who are angry with how the company dealt with the Microsoft offer.

Icahn has nominated a rival slate of directors in an attempt to oust the company's board at its shareholders' meeting Aug. 1, and has recently sent a series of scathing letters to Chairman Roy Bostock urging him to engineer a sale to Microsoft.

With that option seemingly off the table, Icahn's role in the company's future is less clear.

"I think the formal end of the Microsoft deal by Yahoo put a bit of a damper on Icahn's plans," Gartner's Frank said, though he added that analysts and investors are still formulating their preliminary reactions.

"Frankly, I think that this deal was complicated enough that the market hasn't had time to digest it yet," he said.

But the ad deal contains an early termination clause in the event of a change in control of either company.

That means that if Microsoft reopened its bid and completed an acquisition of Yahoo, the ad deal could still be called off. That hope might be enough to keep Icahn engaged in his proxy war.

"Icahn's alternatives seem to now be limited to either cut bait or push with the proxy battle in hopes of electing board members who would bring Microsoft back to the negotiating table," Squali wrote. "We believe he'll opt for the latter."

Next page: What will Washington have to say?