Microsoft takes a shot at main title

After a pursuit lasting two-and-a-half years, Steve Ballmer has finally landed the deal that could give Microsoft a shot at being counted as a true long-term competitor to Google.

However, the costs and risks of the search partnership with Yahoo unveiled on Wedesday are considerable – and they have raised fresh questions about Yahoo’s own long-term future, despite the potential financial benefits of the deal.

The plan, which will see Yahoo give up its own search engine and search advertising technology and contract in future to use Microsoft’s, amounts to Mr Ballmer’s Plan C.

His first proposal, for a full acquisition, foundered after Yahoo resisted an unsolicited bid last year, and the Microsoft chief executive eventually scrapped the idea.

Plan B, advanced last summer, would have seen the software giant take over Yahoo’s search business in its entirety, in return for a large up-front payment and a share of future advertising revenues generated by searches carried out on Yahoo’s sites.

Carol Bartz, Yahoo’s CEO, said on Wednesday that that plan did not meet an important Yahoo criterion: that it should have “skin in the game” over the long term. Rather than take a big payment immediately, she said, Yahoo would rather have a sizeable long-term revenue stream from the search business, and keep an interest in selling the service to its existing advertising customers through a sales force that also sells display advertising. Yahoo’s sales force will also sell advertising to go on Microsoft’s Bing search engine, replacing the existing sales effort.

This “premium” search advertising, which is sold face-to-face, represents more than half the revenues of most of the search services, according to Tim Cadogan, a former head of Yahoo’s search advertising business. The rest is placed direct over the internet by advertisers.

It will all be handled on Microsoft’s AdCenter platform, with Yahoo closing down its own Panama technology, bringing a final end to a troubled development effort that did much to undermine the tenure of former Yahoo CEO Terry Semel.

Being able to place all this advertising on one platform, and having it run by Microsoft, is the single most important goal that Mr Ballmer has had in his long pursuit.

The larger volume of advertising in one place – 22 per cent of search ads in the US, though only 4 per cent for the combined companies in Europe – will greatly increase Microsoft’s ability to place relevant advertising before searchers. It will also help it eventually to narrow the all important “revenue per search” advantage that Google has over both its smaller rivals.

With the unified AdCenter platform, advertisers will also find it easier to adopt a single alternative to Google rather than being forced to manage three fragmented systems, the companies said. At the same time, Yahoo said it would close down its own search engine business, transferring some of the technology and engineering staff to Microsoft, and instead supply results to searches in future using Microsoft’s new Bing search engine, which will enjoy a degree of branding on the Yahoo search page.

Although not the full deal Mr Ballmer once hoped for, this at least cements its position as the challenger to Google, according to analysts. “It’s a sign that Microsoft has proved itself a worthy competitor,” said Allen Weiner, an analyst at Gartner.

But, while appealing in theory, the complexities and risks of the deal still gave Wall Street plenty of pause for thought on Wednesday.

For Yahoo’s investors, the deal does not provide any guaranteed revenue other than in the short-term and exposes the company to long-term risks as it hands over control of search to Microsoft, said Yusuf Squali, an analyst at Jefferies.

Mr Ballmer, meanwhile, was quick to admit the high cost to Microsoft from agreeing to pay Yahoo 88 per cent of the search revenue it collects in the first five years of the deal’s 10-year life, as well as making guaranteed payments for the first 18 months. He also said the software company would face costs running into “hundreds of millions of dollars” as it grapples with the complex job of integrating the two companies’ technology systems.

The complexity also led Yahoo to project that it will not reach the full financial benefits of the deal – $500m a year in higher operating profits, with a $275m addition to operating cashflow and $200m sliced from its capital spending bill – until three years after it closes.

Microsoft and Yahoo will also face some tough questions in Washington and Brussels. Brad Smith, Microsoft’s general counsel, said the deal was was the only way to assure “long-term sustainable competition” to Google.