Yahoo embraces Google after ending Microsoft talks

The news disclosed Thursday caused Yahoo shares to plunge 10 percent as investors abandoned hope that Microsoft would renew a nearly five-month quest to buy the Sunnyvale-based company.

While a stock sell-off is never welcome news for any company, Wall Street's disenchantment comes at a particularly bad time for Yahoo and its board of directors.

Yahoo is trying to fend off a shareholder mutiny led by activist investor Carl Icahn, who has vowed to replace the company's board because of the way the directors handled the Microsoft negotiations.

But Icahn has been hoping to engineer a sale to Microsoft, so some shareholders may be reluctant to support his attempted coup unless he can demonstrate his slate of directors has a better turnaround plan than the current board.

Icahn did not return phone calls seeking comment Thursday.

The fate of Yahoo's board is scheduled to be determined at the company's Aug. 1 annual meeting.

"If you are a Yahoo shareholder, you just have to be scratching your head right now," said Standard and Poor's equity analyst Scott Kessler.

With Microsoft apparently out of the picture, Yahoo is turning to Google to help its chief executive, Jerry Yang, prove he made the right decision last month when he turned down Microsoft's takeover bid of $47.5 billion, or $33 per share. Yang asked for $37 per share, prompting Microsoft CEO Steve Ballmer to withdraw the oral offer.

If the Google partnership passes what's likely to be a rigorous review by U.S. antitrust regulators and lawmakers, Yahoo intends to use it rival's superior search technology to display ads on its own Web site as well as those of its partners' in the United States and Canada.

Yahoo estimated the arrangement could boost its revenue by as much as $800 million during the first 12 months of the partnership.

The deal shapes up as a major victory for Mountain View-based Google, which didn't want Yahoo to fall into Microsoft's clutches.

"I am happy to be helping them to stay independent," Google co-founder Sergey Brin said in an interview Thursday.

Yahoo's advertising partnership with Google won't start until late September at the earliest because the two companies voluntarily agreed to wait at least 31/2 months to allow the government to review a deal involving the two leading players in search advertising.

Google already holds about 75 percent of the $11 billion search advertising market in the United States with Yahoo in a distant second at 9 percent, according to the research firm eMarketer Inc.

Microsoft had hoped to use Yahoo as a weapon in its efforts to slow Google's growth, but they couldn't agree to terms.

"Clearly, it's time to move on," Yang said during a Thursday conference call with analysts.

Before signing the Google deal, Yahoo made a last-ditch effort to persuade Microsoft to revive its last takeover offer of $47.5 billion.

But after withdrawing that bid last month, Ballmer began to focus his efforts on convincing Yahoo to sell its search operations instead.

Yahoo concluded that its search engine was too important to sell piecemeal.

Without explaining its logic, Microsoft said it believed a deal involving Yahoo's search engine would have been more valuable to Yahoo than if it had bought the entire company at $33 per share. The Redmond, Wash.-based software maker said it remains open to buying Yahoo's search operations.

Yahoo's deal with Google includes an escape hatch should Microsoft or another suitor buy the company. If Yahoo is sold, Google would receive a termination fee of up to $250 million.

That clause could still raise hope that Icahn might be able to renew the Microsoft talks if he can win control of Yahoo's board.

Investors clearly favor a sale of Yahoo in its entirety. Yahoo shares dropped $2.63, or 10.1 percent, to finish at Thursday at $23.52, then shed another seven cents in after-hours trading.

The Google partnership expands upon a two-week trial conducted in April while Yahoo was trying to pressure Microsoft into raising its bid. The tests confirmed Google's technology would generate more revenue for Yahoo than its own system, which cost more than $2 billion to acquire and improve.

Nevertheless, Yahoo still intends to use its own search engine to distribute some ads and process all search requests. Working with Google will give Yahoo "the best of both worlds," Yahoo President Sue Decker said in Thursday's conference call.

But Microsoft and a variety of consumer interest groups already have signaled they will turn up the political heat in an attempt to prevent Google from working with Yahoo.

The outcry already has drawn the attention of U.S. Sen. Herb Kohl, who chairs an antitrust committee.

"The consequences for advertisers and consumers could be far-reaching and warrant careful review, and we plan to investigate the competitive and privacy implications of this deal further," said Kohl, a Wisconsin Democrat.

Google and Yahoo have hope they can overcome the antitrust concerns by persuading lawmakers and regulators that their deal is similar to business arrangements between rivals in other industries.

Brin and Google's other founder, Larry Page, both think the partnership could even help foster more competition by providing Yahoo with more money to improve its own search technology. "Having more money is a good thing," Page said.

If it isn't blocked, Yahoo's advertising partnership could last for the next decade.

While a Google deal could help boost Yahoo's short-term profits, some analysts think Yahoo could be hurting itself by ceding any ground its an already powerful rival.

But Yang was under intense pressure to do something bold after Yahoo repeatedly spurned Microsoft attempts to buy the company or arrange some kind of joint venture to challenge Google.

Besides turning down Microsoft's $33 per share bid last month, Yahoo rebuffed an informal bid of about $40 per share early last year, according to a person familiar with those talks. The person didn't want to be identified because the 2007 talks were considered to be confidential.