Yahoo and Microsoft are finally talking seriously about a search-ad partnership, Kara Swisher says. We won’t likely get details on today’s Yahoo earnings call, but the parties could finally be getting closer to a deal.
As has been the case since Carol Bartz took over Yahoo, Microsoft is pushing the talks and Yahoo is playing hard to get. This is as it should be: With only 8% of the US search market, Microsoft must do this deal if it wants to have any chance to build a meaningful search business. Yahoo, which has 20%, would benefit from the deal, but for now it’s holding its own.
The key issue in the talks appears to be the percentage of the payout Yahoo would get on each search term originated on Yahoo, as well as the size of the upfront payment Microsoft would make to Yahoo to buy its search engineering business.
Microsoft executives–including a key M&A and strategy exec, Charles Songhurst, and digital head Qi Lu–have been in Silicon Valley recently in talks with Yahoo execs.
Li, who used to work at Yahoo as a top tech exec in search before moving to Microsoft, is playing a key role in the discussions, said several sources…
Both Yahoo CEO Carol Bartz and Microsoft CEO Steve Ballmer [have] even met in person in Silicon Valley.
That meeting went well, said many, and several Yahoo sources said a deal could come, especially if Microsoft and Yahoo can settle disputes over a number of issues.
That would include the size of the large revenue guarantee and payment Microsoft would make, in exchange for selling Yahoo’s search ads and perhaps more related to search.
In that deal, Yahoo might take over sales of display ads for the pair…
Yahoo is very interested in getting a high TAC rate–basically, a payout to Yahoo on each search query–for example, and also wants to make sure it has rights to all the data related to search.
That’s because some within Yahoo are insistent that search and display need to be closely married together and that it would be dangerous for Yahoo to split them up by outsourcing some of that business to Microsoft.
We disagree with Yahoo about that last bit, by the way. Most advertisers we talk to say search and display advertising are treated as two separate decisions.
We don’t have any info on the terms of the new talks, but here’s what the last Microsoft offer for Yahoo’s search business looked like last summer:
- Microsoft buys Yahoo’s search assets for $1 billion. The search assets include: Code, people, servers, and data centres associated with both Yahoo’s organic search (algorithmic) and paid search (Panama).
- Microsoft and Yahoo enter into a search monetization agreement similar to the one Yahoo signed with Google [which was later terminated]. In this deal, Microsoft would serve Yahoo’s search results–organic and paid–handle the relationships with advertisers, and pay Yahoo a standard revenue split on each paid query. The main differences between this deal and the Google deal would be: Microsoft serves both organic and paid results Microsoft serves ALL Yahoo paid results (the Google deal is partial) Yahoo discontinues any investment in Panama or organic search
- Microsoft serves both organic and paid results
- Microsoft serves ALL Yahoo paid results (the Google deal is partial)
- Yahoo discontinues any investment in Panama or organic search
- Microsoft estimates that the combination of cost savings and revenue boost would drive $1 billion in incremental operating income to Yahoo per year. This is far more than the $250-$450 million expected from the Google deal. It is also, according to the person familiar with Yahoo’s thinking, “a made up number” that depends on assumptions about how much cost Yahoo will eliminate. The person familiar with Yahoo’s thinking says the incremental operating income from the Microsoft deal would be much lower than $1 billion. The familiar-with-Yahoo-thinking person also says that Microsoft’s per-query revenue guarantee was lower than Yahoo is generating today and much lower that the Google deal will generate (i.e., lower revenue to Yahoo). The familiar-with-Microsoft-thinking person says, no, the deal guaranteed more revenue than Yahoo is generating [but not as much as Google.]
- Microsoft buys 16% of Yahoo stock (existing shares) for $35 a share, or $8 billion. This would allow Yahoo shareholders to receive $35 for about 1 in every 6 Yahoo shares they own. It would not result in any additional dilution (or cash on the balance sheet) for Yahoo. The person familiar with Yahoo’s thinking does not dispute this. [This last term was a Carl Icahn term. The new deal almost certainly doesn’t include it.]
ANALYSIS OF WHY YAHOO SPURNED MICROSOFT LAST SUMMER:
Financially, the main difference between the Microsoft deal and the Google deal was that, in Microsoft’s view, the Microsoft deal provided 2X-3X as much operating income and $1 billion of cash. Yahoo disagreed with the operating income assumption and viewed the $1 billion as chump change. .
Strategically, the Microsoft deal would have closed the door on Panama (no going back) and therefore provided Yahoo less flexibility. It also would have forced Yahoo to tell advertisers to book search campaigns using Microsoft instead of allowing them to sell search campaigns directly.
Operationally, the Microsoft deal would have freed Yahoo from having to worry about hiring and managing search engineers, as well as investing in search long term. This would allow it to focus 100% of its energies on display advertising. It would also have deprived it of control over a critical revenue stream and user product. The person familiar with Yahoo’s thinking says this is a risk Yahoo simply wasn’t willing to take (What would happen if the companies entered into a decade-long deal and Microsoft screwed up?)
WHAT HAS CHANGED?
What has changed is that Yahoo’s search share has continued to decline (modestly), and the Google deal is off the table. At this point, it makes little sense for Yahoo to continue to pour money into search engineering when its share of the market will always be puny compared with Google’s. As long as Microsoft is committed to building and maintaining an excellent platform (this is key), it is better for Yahoo and Microsoft to combine forces and build a credible alternative platform to Google.
The key risk to Yahoo, meanwhile, remains a loss of control. If Microsoft screws up a year or two in, and Yahoo has killed all of its search development, it might take the company years to get back to where it is now.
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