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Yahoo!'s Deal With Microsoft Is a Mistake

http://www.fool.com/investing/high-growth/2009/07/29/yahoos-deal-with-microsoft-is-a-mistake.aspx

Rick Aristotle Munarriz
July 29, 2009

Yahoo! (Nasdaq: YHOO  ) CEO Carol Bartz doesn't look much like Wile E. Coyote, but she sure has a funny way of falling into the same animated traps her predecessors did.

Despite the colorful "Microsoft, Yahoo! Change Search Landscape" headline blaring out at us all this morning, the announcement of a partnership with Microsoft (Nasdaq: MSFT  ) really doesn't change much at all.

  • Yahoo! is outsourcing its search platform to Microsoft's Bing -- and in doing so, Yahoo! is repeating the mistake it made when it let Google (Nasdaq: GOOG  ) power its engine.
  • Yahoo! may have set the tone in self-serve advertising several years ago, when it acquired pioneer Overture -- the juiciest part of the online-advertising market -- but now it's letting Microsoft's fledgling AdCenter take over. In other words, Yahoo! is back to milking the less lucrative display advertising market.
  • There will be cost savings and incremental operating profits, but the end result is that Yahoo! will continue to fade in relevance. There's no joy in calling "shotgun," even in a shotgun wedding.

Silly Yahoo!, rifling through the Acme Products catalog -- as if it will ever come up with a third-party contraption to catch up to Google's speedy roadrunner.

Meep-meep!
Shares of Yahoo! opened sharply lower this morning, and not because of the "buy on the rumor, sell on the news" cliches that CNBC has been volleying around this morning. Its depressed share prices comes from two -- and only two -- reasons:

  • There was always a little helium in Yahoo!'s stock, on the dimming hopes of an outright buyout. But this partnership puts an end to any chatter that Microsoft will buy Yahoo! -- in the near term, anyway. After all, why buy the cow when you can get the milk for a fee?
  • Quite frankly, the deal stinks.

Yahoo! could have done better. Microsoft continues to lose money in cyberspace, and it should be on the ropes right now, just days after posting its first annual revenue decline since going public. It's enough to make one wonder whether Yahoo! conducted a sobriety test before handing the software giant the keys this morning.

Microsoft will compensate Yahoo! for rolling over. In exchange for letting it plaster Yahoo!'s query result pages with Microsoft-sold ads, Yahoo! will receive 88% of the resulting revenue through at least the first five years of the 10-year term. That's a big number -- Google shared just 74% of its gross partner revenue with publishers this past quarter -- but it's not big enough.

Slicing pies and taking names
There's more to math than percentages. For starters, it's been widely assumed that Google offers far more than the 74% average to its largest customers. You also have to consider the pie being divided. Google is the undisputed leader in online advertising. More sponsors translate into better keyword bids and a deeper bench of relevant ads.

Google's girth should translate into higher click-through rates, so 74% of something is better than 88% of nothing.

Yes, Microsoft is guaranteeing revenue-per-search minimums in every country, but only for the first 18 months of a 120-month deal.

Yahoo! claims that it will be able to reap immediate results. Operating income will grow by $500 million annually. The consolidation will allow it to shave annual capital expenditures by $200 million.

Missing in the mix is the long-term cost of letting Microsoft become the silver medalist in search algorithms and paid search. By ceding its search capabilities to Microsoft and getting rid of its search developers, Yahoo! is putting itself in a weak negotiating position when it comes time to renegotiate this deal 10 years from now. What's more, taking a weedwhacker to capital expenditures is a eup