Yahoo and Microsoft CEOs Finally Talking About a Search Deal; Maybe More?

Posted by: Rob Hof on April 10, 2009

In a development that can’t be too surprising but may help revamp the Internet landscape, Yahoo CEO Carol Bartz and Microsoft CEO Steve Ballmer have started talking about forging Internet search and advertising deals.

First reported by Kara Swisher in a post on the AllThingsD blog Boomtown this morning, the talks are at an early stage. They include “many scenarios, such as one in which the companies swap online advertising assets and deliver services to each other.” Yahoo “might take over all of Microsoft’s display and premium advertising business to sell along with its own, while Microsoft would run the search advertising business for the pair.”

One source close to the situation tells me the talks are very preliminary indeed. They don’t involve Microsoft buying Yahoo outright. Neither is a simple outsourcing of Yahoo’s search to Microsoft likely, because Yahoo under Bartz has made it clear the company considers Yahoo’s search business, which trails far behind Google’s but far ahead of Microsoft’s, a valuable asset it wouldn’t easily part with.

Microsoft has repeatedly indicated in recent months that it’s still interested in a search deal with Microsoft. And recent comments from Microsoft executives indicate it believes its search technology is ready for prime time but lacks the scale of customer use that Yahoo could provide. But the appointment of Bartz as new Yahoo CEO in January, replacing cofounder Jerry Yang, effectively put further discussions on hold while Bartz got her footing.

It’s believed that if Bartz did agree to a deal, it would have to allow Yahoo continued access to data on Yahoo searches. That data is exceedingly valuable for mining buying intentions. As such, it’s considered crucial for Yahoo to better target display ads, which is its mainstay business, to just the right people and thereby boost dropping ad rates. As Bartz said in an early March interview at a Morgan Stanley conference: “Search data is extremely important.”

A number of people have suggested the attractiveness of a larger arrangement between the two companies, in which Microsoft would handle all search ads for the two companies and Yahoo would take over display ads for the pair. But it’s not clear that big a deal, which could be complex, is under serious discussion. Indeed, the apparently broad nature of discussions may indicate both sides are posturing for the best deal. Standard & Poors analyst Scott Kessler says he won’t get excited until it’s apparent a deal has been struck. Until then, he adds, “it’s a lot of talk.”

Not least, for Yahoo, any deal would also have to include a whopping big check from Microsoft, and likely ongoing payments. Yahoo probably wouldn’t want such a deal to continue indefinitely, since if the deal allowed Yahoo to invest in and strengthen other parts of its business, it would want to retain the ability to take back control of search in the future—or at least play Microsoft off Google. A deal for Google to place ads on Yahoo search results imploded last summer, abandoned by Google when it was faced with the threat of an antitrust lawsuit by the Justice Department.

For all those reasons, a Yahoo-Microsoft deal could take some time to work out. What may make it happen this time is that the two companies more than ever need each other to compete with Google, whose share of Internet searches remains as high as 72%—and whose share of search advertising revenues likely tops 80%. With search slowing and Yahoo and Microsoft continuing to lose ground to Google, shareholder pressure seems sure to rise on the two companies to find common ground.

Meantime, Yahoo faces the potential loss of search market share in the coming year and a half as its agreement with Hewlett-Packard and Acer to promote its browser toolbar expire. Because Yahoo is the default search engine on those toolbars, the end of those deals could eliminate some search traffic to Yahoo. Collins Stewart analyst Sandeep Aggarwal suggests that a deal for Microsoft to take on search could save Yahoo up to $800 million in expenses annually and might include an upfront payment by Microsoft of $2 million to $3 million and an annual search ad revenue share of up to $2 billion for several years.

Meantime, Microsoft has hired a number of Yahoo search executives and engineers, including Qi Lu, now head of all of Microsoft’s online businesses. And it’s preparing for a summer launch of a major new version of its search engine.

Stocks aren’t trading today, Good Friday, so we don’t yet know what shareholders think of the new development. Whatever the particulars of any deal, they’re less likely than last year’s acquisition talks to get leaked until they’re pretty much wrapped up. As Bartz said recently: “I said this to Mr. Ballmer: I’m not going to negotiate with my 50,000 favorite friends. We are going to negotiate as companies negotiate, and that is privately.” But apparently not as privately as she would like.

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Bloomberg Businessweek writers Peter Burrows, Cliff Edwards, Olga Kharif, Aaron Ricadela, and Douglas MacMillan, dig behind the headlines to analyze what’s really happening throughout the world of technology. Tech Beat covers everything from tech bellwethers like Apple, Google, and Intel and emerging new leaders such as Facebook to new technologies, trends, and controversies.

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