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Google (Nasdaq: GOOG  ) is doing both Yahoo! (Nasdaq: YHOO  ) and itself a solid by calling off its pending ad deal this morning. Scrutiny had grown so loud and the concessions were so crippling that it just wasn't worth it for either company at this point.

The only real surprise here is that it was Google that beat Yahoo! to the kill switch.

The rise and fall of Yahoogle
The deal started logically enough. With a stalemate in its combination talks with Microsoft (Nasdaq: MSFT  ) , Yahoo! opted to become the largest client of Google AdSense in April. It made sense. Yahoo! may run the country's second most successful paid search platform, but it's a distant silver medalist to Google. With its deeper ad inventory of high-paying relevant ads and arguably superior ad-targeting technology, outsourcing its paid search space to Google was a pride gulper, but it made financial sense. More money. Less overhead. Yahoo!'s margins have always been pathetically inferior to Google's throughput, and now it had a practical way to ride Big G's coattails for a change.

The initial test went well. Yahoo! was so encouraged that it went public with its projections for the deal to generate as much as $450 million in incremental operating cash flow and $800 million in revenue.

Then critics began rocking the boat from both sides. Webmasters who rely on AdSense, advertisers that bank on Google's AdWords, and even Microsoft started to complain. The fears couldn't all be founded. If advertisers felt that fewer competitive outlets would drive keyword bidding prices higher, publishers would be making more. The only way that both parties would lose is if Google would shave an even larger amount of the proceeds it pays back to its AdSense publishers. Would Google do that and risk alienating everybody?

Antitrust regulators couldn't ignore the smoke. They stepped in, and both Google and Yahoo! agreed to hold off on implementing the deal. The Wall Street Journal's online edition on Monday reported that Google and Yahoo! were watering down the original deal to clear regulatory hurdles, no doubt fearing defeat under terms of the original plan. The 10-year pact became just a two-year deal. An open-ended arrangement turned into a capped one, where Yahoo! would only turn to Google for 25% of its ad revenue. Would the same regulators that let the only two satellite radio operators come together in Sirius XM Radio (Nasdaq: SIRI  ) earlier this year really get in the way of two paid search stars when the advertising realm is so much wider?

It's immaterial, I guess. Yahoo! and Google were spooked into hosing down the deal to the point of ineffectiveness.

"At some point, going through with this deal could be more detrimental than incremental for Yahoo!," I wrote yesterday. "We may have reached that point right now."

I guess I was right. Again, the only real shocker here is that Google was the first one to publicly walk away.

What now, Yahooligans?
So where does Yahoo! go from here? It can't go back in time, pretend that nothing ever happened, and sit on Mr. Softy's lap. The very act of entertaining the outsourcing of its ads will make it hard to keep sponsors and publishers who now see Google as the more attractive option.

Organic growth appears unlikely in the near-term, so Plan C may be drumming up combination talks with Time Warner's (NYSE: TWX  ) AOL. That would be stupid. Stupider than stupid, actually. AOL revenue fell by a sharp 17% this past quarter, with a head-turning 6% dip in online ad revenue. If Yahoo! wants a shoulder to cry on, please don't let it be a sinking shoulder. parent IAC (Nasdaq: IACI  ) would be a much better choice. At least IAC's online ad revenues are going in the right direction. Beefing up its display advertising stronghold by snapping up ValueClick (Nasdaq: VCLK  ) may be Plan D, but that would also be a mistake. ValueClick's revenue also declined this past quarter. Besides, paid search -- not display advertising -- has at least some hope of growth in this sponsor-tiring market.

This naturally leads back to Plan A: falling back into Microsoft's arms. It makes sense. It makes perfect sense. However, it would be at a much lower price for Yahoo!. It also would require Microsoft to batter its shareholders the way it did when it presented its first buyout offer with another dilutive push.

This brings us to Plan E. I doubt the Yahoo! playbook runs that deep, but it may be the next sad chapter in this unfulfilling tale.

Plan E? How about Plan Everyone? Use the comment box below to describe how you would save Yahoo! at this point.   

Some other articles to read before deciding what Yahoo! is really worth:

Microsoft is a Motley Fool Inside Value pick. Google is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletters today, free for 30 days.

Longtime Fool contributor Rick Munarriz spends plenty of time on Yahoo!'s sites, but he does not own shares in any of the stocks in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 05, 2008, at 2:33 PM, Dadw5boys wrote:

    Yahoo searches work better for me. I hate the search results I get from google. The ones who pay the most get top of the search pile. I hate digging 8 layers deep to find what I get from Yahoo. search on the first page.

  • Report this Comment On November 05, 2008, at 2:47 PM, DemianBohemian wrote:

    This is your 5th worthless article in a row name dropping or slamming for hits. You guys were recommending XM to your paid subscribers at over $30 a share and now you bash it on a daily basis down in the pennies! What kind of pump and dump scam are you trying to pull?

    Please offer some worthwhile analysis or you will continue to lose credibility...

  • Report this Comment On November 05, 2008, at 2:51 PM, conwayguy2001x wrote:

    Wow, I've watched people bash you because you "bait" people by mentioning SIRI in your articles to get hits, but dayum, this one is obvious. This article has NOTHING to do with SIRI and I regret clicking the link...but alas, my yahoo page shows me the source of articles so I'm removing any and all that originate from Motley Fool....I bought at $30 like you gonna pay me the difference due to your HORRID stock advice?

  • Report this Comment On November 06, 2008, at 1:39 AM, MHK1 wrote:

    I could care less about his SIRI analogy, Fool unfortunately I'm long an YHOO at 26, so I follow you & Kara often. You guys have a good handle on this one. That said, the option you are seeking is simple, fire Jerry, Sue & Roy. You can replace them with Mickey Mouse, Dumbo & Pluto at this point and the stock will increase by 20%. The scorecard for a CEO is easy: What is the stock price? Jerry, et. al. turned down $33 and we hit $11.25 a few days ago. Clearly they failed us, fiduciary responsibility be damned. I love Yang's comments today that he's in favor of an MSFT deal and that they walked away. Memo to Jerry, they offered $31 in Febuary and you were still jerking them around in May, nice try. $37 was a wet dream that only you shared. YOU BLEW IT JERRY. Now check your ego at the door, shut up and listen to Carl. In fact, go on vacation and let Carl close the deal. He's in at $25 so we can assume that he wants a deal and won't give away the store. You're too emotionally attached to the deal so go golfing or go finish your PhD, either way, get the hell out of the way and let the adults close the deal.

  • Report this Comment On November 06, 2008, at 1:06 PM, Tombstone1954 wrote:

    I think in the near future that Google will fall in both price ,& in reliabilty because of Hackers attacking Google,& their staff failing to provide adequate solutions.Its already a toss-up when you click on a Google link,whether you`re down-loading a Phishing look-alike,or the real thing,.Yahoo would be better served by allowing Microsoft to absorb them.God knows they do not have the funding,or the management smarts to continue on their own...

  • Report this Comment On November 24, 2008, at 4:49 PM, loosecabooseus wrote:

    i agree with many of the comments here, i once thought the motley fool was a credible website with good analysis, thus far ALL the picks they write about, all their analysis, has been wrong (except for the article about how mutual funds are expensive). I think MF is a Pump n Dump site. i don't believe their statements about not accepting money from companies etc. my analysis of yahoo, however: i think they should focus on structuring themselves to be what they are good at, virtual real estate. why not purchase the ny times, and become a full fledged media conglomerate. they already have a huge share of the mainstream net audience, now they just need to focus on content. instead of competing against microsoft and google, in territories that they are dominant, why not compete against those who have been weekend by yahoo's presence? buy nyt at $6/share buy CBS at $6/share and there you have a huge market of net, print, & tv, an invaluable piece of real estate to generate and distribute content! an advertiser's heaven! imagine if eastman kodak purchased adobe back in the day they would have a future in the digital image sphere now...

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