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Microsoft and Yahoo Announce 10-Year Search Deal

Posted by: Rob Hof on July 29, 2009

And so the deal is finally done: Microsoft and Yahoo early this morning announced a 10-year deal that provides a united front against search giant Google. As we wrote last night, the deal essentially turns over Yahoo’s search service to Microsoft and its newly launched Bing search engine, while Yahoo will be responsible for all search ad sales, using Microsoft’s ad sales technology.

Although Yahoo estimates the deal will mean $500 million a year in operating income, $200 million in savings on capital spending, and $275 million in extra operating cash flow, investors don’t appear too happy. The stock is down nearly 10% in early trading. They may be reacting to the lack of a large upfront payment that was rumored in earlier talks, as well as the uncertainty about how well the complex deal will be executed.

Most analysts seem to think Microsoft got the best of the deal, paying relatively little money (compared with its huge reserves and cash flow) essentially for control of the No. 2 position in search vs. Google. While Yahoo gets a fair amount of cash, it no longer will have fundamental search technology, arguably still the key technology of the Internet age. For what it’s worth, Jason Calacanis of the people-powered search firm Mahalo, thinks Yahoo just committed suicide. Larry Dignan at ZDNet’s Between the Lines blog also draws disturbing parallels between Yahoo and AOL.

But if Yahoo can actually execute on its promise to focus its resources on rejuvenating its brand, user experience and most of all display, video, and emerging forms of nonsearch advertising, it may also win ultimately. That’s the counterpoint view of venture capitalist Bill Gurley, who questions how it makes sense to pursue a runaway leader like Google on its own turf.

In any case, both Microsoft and Yahoo have a lot of work to do for the deal to work for either. The deal will take until at least early next year to close, and that’s assuming everything goes smoothly and antitrust officials don’t take too long approving it.

A smooth transition is far from certain. Yahoo CEO Carol Bartz and Microsoft CEO Steve Ballmer said on a conference call this morning that the term sheet for the deal is well over 100 pages long. “That’s why we had to make sure we had a partnership” as opposed to a one-off deal, Bartz said, conceding the “distraction” of integrating the companies’ search operations. As Henry Blodget at Silicon Alley Insider notes, splitting technology and sales creates inevitable conflicts.

Bartz also said a large upfront payment with lower revenue sharing wasn’t as interesting to Yahoo because “we’re trying to run a long-term business. This a true partnership. Frankly, both of us have skin in the game.” Yahoo “needed to get focused,” she added, and this helps it achieve her stated goal of being the center of people’s lives online. What’s unsaid is whether Yahoo simply couldn’t negotiate a large upfront payment. But at the same time, retaining search ad sales, even on Microsoft’s technology platform, does give Yahoo more control over the breadth of ad sales on its sites.

Bartz posted briefly on Yahoo's blog. Here are the basics of the agreement, from the release:

* The term of the agreement is 10 years;

* Microsoft will acquire an exclusive 10 year license to Yahoo!'s core search technologies, and Microsoft will have the ability to integrate Yahoo! search technologies into its existing Web search platforms;

* Microsoft's Bing will be the exclusive algorithmic search and paid search platform for Yahoo! sites. Yahoo! will continue to use its technology and data in other areas of its business such as enhancing display advertising technology;

* Yahoo! will become the exclusive worldwide relationship sales force for both companies' premium search advertisers. Self-serve advertising for both companies will be fulfilled by Microsoft's AdCenter platform, and prices for all search ads will continue to be set by AdCenter's automated auction process;

* Each company will maintain its own separate display advertising business and sales force;

* Yahoo! will innovate and "own" the user experience on Yahoo! properties, including the user experience for search, even though it will be powered by Microsoft technology;

* Microsoft will compensate Yahoo! through a revenue sharing agreement on traffic generated on Yahoo!'s network of both owned and operated (O&O) and affiliate sites;

* Microsoft will pay traffic acquisition costs (TAC) to Yahoo! at an initial rate of 88 percent of search revenue generated on Yahoo!'s O&O sites during the first five years of the agreement; and

* Yahoo! will continue to syndicate its existing search affiliate partnerships.

* Microsoft will guarantee Yahoo!'s O&O revenue per search (RPS) in each country for the first 18 months following initial implementation in that country;

* At full implementation (expected to occur within 24 months following regulatory approval), Yahoo! estimates, based on current levels of revenue and current operating expenses, that this agreement will provide a benefit to annual GAAP operating income of approximately $500 million and capital expenditure savings of approximately $200 million. Yahoo! also estimates that this agreement will provide a benefit to annual operating cash flow of approximately $275 million; and

* The agreement protects consumer privacy by limiting the data shared between the companies to the minimum necessary to operate and improve the combined search platform, and restricts the use of search data shared between the companies. The agreement maintains the industry-leading privacy practices that each company follows today.

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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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