Marcial: 'An Excellent Deal' for Yahoo

Carl Icahn says Yahoo couldn't afford to keep competing against Microsoft and Google. But many analysts and investors are skeptical about the search agreement

Yahoo— 52-week stock price

By Gene Marcial

BW's Gene Marcial

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Activist investor Carl Icahn, who has a pivotal 5% stake in Yahoo! (YHOO), is one of the few fans of the much ballyhooed search agreement that Yahoo signed with Microsoft (MSFT) on July 29. "I think it is an excellent deal, and Yahoo CEO Carol Bartz and her team did an excellent job under the circumstances," says Icahn, who has kept silent about the much criticized search deal until now.

"I agree with [Microsoft CEO Steve] Ballmer that the deal benefits Yahoo in that Yahoo gets 88% of the search revenues under the agreement," said Icahn in a phone interview on the evening of July 31.

The veteran stock activist says he has been "a strong advocate of Yahoo doing a deal with Microsoft on the search business" ever since he bought Yahoo stock a year ago. Icahn was mainly responsible for the ouster of former Yahoo CEO Jerry Yang, who had quibbled and eventually turned down Microsoft's hefty offer in early 2008 to buy all of Yahoo for $45 billion. "But that's now under the bridge," says Icahn, "and now Yahoo had to do a deal with Microsoft."

Cost of Competition

Icahn says that, like Ballmer, he couldn't understand the reasoning behind Wall Street's criticism of the deal. "Yahoo can't afford to continue competing with giants Google (GOOG) and Microsoft," says Icahn. With this deal, "Yahoo will be able to partner with Microsoft against Google, and allow [Yahoo] to focus more and spend more on its content business, which is a tremendous growth area [where] Yahoo has a leg up."

"I am pretty happy that we got a deal with Microsoft," says Icahn, who emphasized that the deal will save Yahoo a lot of money in keeping its foothold in the increasingly competitive search business. The cost of competing with Google and Microsoft in search is tremendous, notes Icahn, and this partnership with Microsoft will greatly benefit Yahoo in that sense alone.

"I believe that the partnership with Microsoft bodes very well for Yahoo's long-term outlook and future," he adds. Some Yahoo bulls believe the Microsoft-Yahoo partnership signals more opportunistic ventures for both companies in the future. "Who knows what else will come in the future because of this partnership," says one big investor in both Yahoo and Microsoft.

Yahoo and Microsoft have agreed to combine their search platforms over a 10-year period, with Yahoo adopting Microsoft's Bing search engine and receiving 88% of revenues from ads sold on its sites for the first five years, with a revenue-per-search guarantee for the first 18 months. With the agreement, Microsoft and Yahoo will have about 30% of the search business, still way behind Google's 65%.

Deal Doubters

Many investors and analysts don't share Icahn's enthusiasm. After the agreement was announced on July 29, Yahoo stock fell from 17.22 on July 28 to 14.32 on July 31. On the other hand, Microsoft's stock stayed firm, at 23.47 on July 28 and 23.52 on July 31.

"The terms of the deal were underwhelming," groused Heath Terry, tech analyst at FBR Capital Markets (FBCM), who reiterated his stock rating of underperform after the deal was announced.

"We are increasingly concerned about the strategic ramifications [of Yahoo] losing the direct relationship with major advertisers in years 5-10 that are necessary to promote a combined search-branded offering," says analyst Marianne Wolk of Susquehanna Financial Group, who maintained a neutral stance on Yahoo.

A leading Internet portal with more than 350 million unique users worldwide, Yahoo offers a one-stop shop for a variety of services, such as e-mail and shopping. The bulk of its revenues come from online advertising, mainly from search, branded ads, and classifieds.

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