As Yahoo! (Nasdaq: YHOO) lost its second Asian partner in two months, the company's search alliance with Microsoft (Nasdaq: MSFT) became the subject matter of investor concerns.

The key concerns include whether Yahoo! will lose more affiliate partners, and if the deal with Microsoft is making Yahoo!'s affiliate relationships weaker.

The Yahoo!-Microsoft search alliance was dealt a new blow this week when South Korea's NHN decided to part ways with Yahoo! by the end of this year, depriving some scale advantages of the alliance.

NHN Corp., which owns over 60 percent of South Korea's search market, will discontinue using Yahoo!'s search advertising service in Korea and will begin using its own technology once its search advertising agreement with Yahoo! ends in November 2010.

The Korean company cited that it needs a more flexible system that's suitable for Korean advertisers.

Analysts are disappointed with the development and say the loss of NHN could make tougher for Yahoo! and Microsoft to compete in the South Korean market despite the recent addition of Daum and Nate, the Nos. 2 and 3 search engines in Korea, to their kitty.

NHN's move marks the second time in two months that an Asian partner dumped Yahoo!, which is in the process of outsourcing its own search technology to Microsoft's Bing.

In July, Yahoo! Japan said it would use Google (Nasdaq: GOOG) instead of Yahoo! to power search on its site, and Yahoo! Japan CEO Masahiro Inoue commented that Yahoo!'s search technology was not "sufficiently strong enough for (the company's) needs." However, Yahoo! Japan will pay Yahoo! a percentage of search revenue till 2017.

"Though Yahoo! continues to get payments from Yahoo! Japan through 2017, we believe the additional loss of NHN further reduces the scale benefits of the search alliance with Microsoft," UBS analyst Brian Pitz said in a note to clients.

Pitz, who has a "neutral" rating on Yahoo!, cut his price target on the stock to $15 from $17 and said Microsoft is likely to focus on gaining share in the U.S., given Google's and local search engines' dominant positions overseas.

"The loss of NHN comes one month after Yahoo! Japan announced that it would move search to Google, and it represents another hit to the Yahoo!-Microsoft search alliance as it reduces the ultimate scale opportunity," Barclays Capital analyst Douglas Anmuth said in a recent note to clients.

Anmuth said the latest move by NHN, which operates Naver search engine in South Korea, could lower Yahoo!'s 2011 gross revenue by as much as 10 percent, but reduce net revenue and EBITDA by only 1-2 percent given a very high traffic acquisition cost (TAC) payout.

Yahoo!, in a regulatory filing, said NHN represented less than 1 percent of its gross profit in the first half of 2010.

Anmuth estimates that NHN would account for roughly $600 million in gross revenue for Yahoo! this year, but it represents only about $30 million in net revenue assuming a TAC rate of 95 percent.

Pitz estimate roughly $400 million negative impact to Yahoo!'s 2011 gross revenue and $40 million to net revenue (using 90% TAC) and EBITDA.

"We believe NHN is by far Yahoo!'s largest search affiliate on a gross revenue basis, but Yahoo! Japan contributes much more net revenue and EBITDA," Anmuth said.

Microsoft and Yahoo! had spent billions of dollars trying to beef up their Web search capabilities and mount a challenge to Google's online search hegemony. The bids failed, and the two companies struck a deal last year to streamline and sharpen their search capabilities.

The deal opened a new avenue for Microsoft's search engine, which was overhauled and renamed as Bing. For Yahoo!, the opportunity lay mainly in strategic and financial aspects.

The two companies said it would take two years to fully implement the project to integrate search operations globally.

Yahoo! and Microsoft are now working on Yahoo!'s transition to using AdCenter, Microsoft's self-serve search ad platform.

Microsoft recently indicated that Yahoo!'s paid search integration to MSFT's AdCenter will begin this week and is on track for completion in late October.

"Hitting the deadline ahead of the holidays would suggest better execution from YHOO and there could be some early revenue per search (RPS) benefits in 4Q, but we also don't expect any real shift in advertiser budgets until 2011," analyst Anmuth said.

Caris and Co analyst Sandeep Aggarwal, who has a "buy" rating and $20 price target on the stock, said he believes that in addition to integration happening well in time, the alliance will boost shares of Yahoo! by bringing a possible upside to RPS, higher than expected savings in operating costs and stabilization of search share.

"We continue to believe that there is upside to Yahoo! but absence of near-term 'tangible' catalysts beyond Bing and precarious economic outlook mean investors may have to keep more patience to realize the upside in shares," Aggarwal said.

International Business Times, The Global Business News Leader

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