Microsoft spurned as Yahoo, Google strike alliance

The on-again, off-again deal dance between Microsoft and Yahoo finally ended with Yahoo in Google's arms.

Yahoo said in a statement Thursday that weeks of talks about Microsoft's proposal to buy just Yahoo's search business had ended without a resolution. Hours later, the company announced a search-advertising partnership with Google.

Microsoft already had waved the antitrust flag at the prospect of a tie-up between Google, its top rival and the runaway leader in Internet advertising, and Yahoo, the company it sought to acquire to narrow the gap.

The Yahoo-Google partnership, which Yahoo described as open and nonexclusive, is the opposite of what Microsoft was seeking when it made public in February its unsolicited offer to buy Yahoo for $31 a share, or about $44.6 billion.

"It's obviously damaging when you have two of the other leaders in the industry come together," said Brent Thill, director of software research at Citi Investment Research. "And it certainly is not good in the near term as it relates to Microsoft's overall market share."

Google has been gaining share — it had 62 percent of the U.S. search market in April — at the expense of No. 2 Yahoo and Microsoft, which has seen its share dip below 10 percent.

The Yahoo-Google deal, which is for an initial term of four years with options to extend to 10, will put Google ads next to results from Yahoo's search engine and some non-search Web sites in the U.S. and Canada.

The companies will share revenue from these ads, and Yahoo will maintain its own search engine and separate advertising platform. Yahoo said the arrangement would add $250 million to $450 million to its cash flow in the first year.

Federal review

In an attempt to address antitrust concerns, Google and Yahoo "have voluntarily agreed to delay implementation for up to 3 ½ months while the U.S. Department of Justice reviews the arrangement," Yahoo said in a news release announcing the deal.

Yahoo Chief Executive Jerry Yang said that because it's a commercial agreement, "there's no real formal regulatory requirement."

Still, the deal is drawing scrutiny.

"Both Google and Yahoo are saying this is good for competition, and I just don't see it," said Sid Parakh, technology analyst with Seattle's McAdams Wright Ragen. Instead, he sees Google gaining more power over advertisers.

In addition to search advertising, Yahoo and Google said users of their respective instant-messaging services will be able to communicate. Microsoft has a similar arrangement with Yahoo.

U.S. Sen. Herb Kohl, D-Wis., chairman of the Senate Antitrust Subcommittee, issued a statement pledging to "closely examine" the joint venture between Yahoo and Google.

"This collaboration between two technology giants and direct competitors for Internet advertising and search services raises important competition concerns," Kohl said.

Yahoo, based in Sunnyvale, Calif., emphasized that its deal with its Mountain View-based neighbor is nonexclusive.

Open to others

"This does not preclude us from opening up to other search partners as well," said Sue Decker, Yahoo's president, during a conference call with analysts.

Analysts saw little likelihood of any sort of deal between Yahoo and Microsoft after Thursday.

The two companies had been talking since May 18 about a sale of just Yahoo's Internet search business, an alternative Microsoft proposed after withdrawing its offer to buy all of Yahoo.

Yahoo's board didn't think the company could go forward without that critical online asset, Yahoo said in a statement, declaring its negotiations with Microsoft dead.

Microsoft said the proposed alternative transaction "would have delivered in excess of $33 per share to the Yahoo shareholders" — the amount CEO Steve Ballmer had orally offered before he withdrew his bid the weekend of May 3.

"Healthy competition"

Moreover, it "would ensure healthy competition in the marketplace, providing greater choice and innovation for advertisers, publishers and consumers."

The company has made the latter argument — that combining the search businesses of Yahoo and Microsoft would form a counterweight to Google's dominant market share — since it first proposed acquiring Yahoo.

Microsoft is no longer interested in a full buyout of Yahoo.

At a meeting Sunday, "Microsoft representatives stated unequivocally that Microsoft is not interested in pursuing an acquisition of all of Yahoo, even at the price range it had previously suggested," according to Yahoo's statement.

Microsoft reiterated this position and, unlike in earlier statements during the months-long drama, the company did not explicitly reserve its right to revisit a full acquisition in the future.

"Our alternative transaction remains available for discussion," Microsoft's statement Thursday concluded.

Microsoft shares traded sharply higher after the deal's collapse became public. Its stock closed at $28.24, up $1.12, or 4.1 percent. Yahoo shares, meanwhile, fell $2.63, or 10.1 percent, to $23.52.

The announcement of the Google and Yahoo deal came after the markets had closed.

Stock weighed down

"This whole Yahoo deal has been a massive boat anchor on Microsoft's stock," said Thill, the Citi analyst. "This could potentially help alleviate some of the near-term weight on the shares."

Microsoft is left to fight the Google juggernaut on its own.

Recent moves include the launch of Live Search cashback, a program that gives shoppers some of the revenue Microsoft earns when they buy products from companies that advertise on its search engine — essentially paying people to use it.

It also inked an exclusive distribution deal with Hewlett-Packard, including a custom search toolbar and setting Microsoft's Live Search engine as the default in Internet Explorer on new consumer PCs sold in North America beginning in January.

Analyst Parakh said Microsoft needs to quickly score more such deals.

Consumer confusion

Matt Rosoff, analyst at Kirkland-based Directions on Microsoft, said the company has a branding problem. Consumers are confused by its Live, Windows Live and MSN online brands. They don't know what Microsoft's search engine is called or what Web address to enter to use it.

The company could launch a marketing blitz to address the problem, but "it might take some pretty significant spending," Rosoff said.

Microsoft also may narrow its online focus to a few core areas, Rosoff said.

It recently dropped its effort to scan books and academic journal articles for publication online, leaving that to the publishers themselves. It also halted its online classified service.

"We might see some refocusing, but everything I hear and see is they are putting more resources in search," Rosoff said. "They're really committed to trying to be a player in search."

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com