Inside Google

The Microsoft and Yahoo search partnership announced Wednesday may have
been years in the making, but underwhelmed investors and analysts
dwelled on the fact that it will take at least two more years to
implement.

That’s a veritable Internet eon that could give Google Inc. time to
build on its online search lead and leave a struggling Yahoo without
any immediate financial benefits. Shares of the Sunnyvale company
dropped more than 12 percent Wednesday, closing at $15.14.

The 10-year deal, which will require regulatory approval, forms a
united front in what the companies suggest will be an intense assault
on Google’s dominance in online search.

Under the terms of the alliance, Microsoft’s Bing search tool will
become the exclusive platform on Yahoo’s sites, funneling an enormous
volume of queries through the Redmond, Wash., software titan’s
increasingly popular algorithm.

In turn, the Web portal will sell advertising tied to online search
for both companies. Microsoft will pay Yahoo for the traffic it
generates, providing what Yahoo hopes will be a windfall that helps
reverse its fading fortunes.

Yahoo estimates the agreement will add $500 million to its annual
operating income and save $200 million in capital expenditures, though
not until two years after the deal is approved.

"By combining the scale and technology of both companies, we can
offer a real viable alternative for users and advertisers, which is
good for everyone," Yahoo CEO Carol Bartz said during a conference
call.

Talks began in 2005

The deal, expected to close in early 2010, comes more than a year
after Microsoft made an ill-fated $47.5 billion takeover bid for Yahoo.
The two parties had entertained a partnership since 2005.

Though Google isn’t mentioned by name in the news release outlining
the partnership, the deal is a clear shot at gaining momentum against
the search king, based in Mountain View. Microsoft CEO Steve Ballmer
said the agreement will enable Bing to attract more users and
advertisers, which will improve the relevance of its ad and search
results.

The deal provides "consumers and advertisers with greater
transparency and choice and (creates) really a strong No. 2 player in
search," he said on the call.

Microsoft introduced its improved and newly named search service
early last month, accompanied by a $100 million marketing campaign. It
earned early praise from reviewers and helped nudge up Microsoft’s
share of the search market by 0.4 percent in a month.

Even together, however, Microsoft and Yahoo would rank a distant
second in search. Google controls 65 percent of online searches,
according to a June report by ComScore Inc. That compares with just 28
percent for Yahoo and Microsoft combined.

Ultimately, the partnership doesn’t shift search rankings, boost
advertising rates or loosen Google’s stranglehold on the market, said
Carl Howe, a director at research firm Yankee Group. "The amazing thing
about this deal is how little has changed," he said.

Several analyst reports released Wednesday echoed those criticisms.

Aaron Kessler, a senior analyst with Kaufman Bros. LP, said the
alliance does allow both companies to play to their core strengths and
could represent at least a first step in turning around Yahoo.

He attributed the Sunnyvale company’s stock decline to the absence
of any immediate payments from Microsoft. The software company’s shares
rose 1.4 percent on the news, closing at $23.80.

Competition online

Google continues to create services designed to compete with
Microsoft and Yahoo. The company recently announced plans for a free
operating system for personal computers, dubbed Google Chrome OS, which
attacks the very core of Microsoft’s business.

And Google’s popular search tool has been undermining Yahoo’s market share for years.

Many investors saw Microsoft’s $47.5 billion bid last year as the
best bet for a turnaround at Yahoo. But leaders, including Yahoo’s
then-CEO and co-founder Jerry Yang, said the price significantly
undervalued the company, and Microsoft eventually withdrew the offer.
On Wednesday, Yahoo’s market capitalization was $21.4 billion.

Yang stepped down in November and was replaced by Bartz, who set out
to overhaul the company. It has proven no small feat amid the faltering
economy. Earlier this month, Yahoo said second-quarter revenue dropped
nearly 13 percent to $1.57 billion, as online ad sales continued to
shrink.

After Microsoft’s proposed acquisition fell apart, Google swept in
with an advertising partnership offer for Yahoo. The plans fell apart
under threat of a lawsuit by the Justice Department, which indicated
that such a deal would hand Google too much control of the online
advertising market.

Scrutiny expected

Microsoft and Yahoo clearly are bracing for regulatory scrutiny. The
news release emphasized that the two companies will "continue to
compete vigorously" in other areas, including e-mail, instant messaging
and display advertising. It also stressed that the agreement restricts
the sharing of search and other data.

Consumer Watchdog in Washington, D.C., called on the Justice
Department and Federal Trade Commission to probe the deal for potential
antitrust violations and privacy concerns.

Ballmer said during the conference call that he expects Google to be
aggressive in lobbying against the deal, but expressed confidence that
regulators would ultimately approve it.

Google limited its comments on the alliance to a statement: "There
has traditionally been a lot of competition online, and our experience
is that competition brings about great things for users."

The Associated Press contributed to this report. E-mail James Temple at [email protected].