As we first reported yesterday, Microsoft and Yahoo are on the verge of announcing a complicated search and search marketing alliance that will combine the no. 2 and no. 3 players in search into something that may have a chance of competing with Google (although combined they will still have less than half of Google’s 65% or so search market share). The deal will be announced shortly after signing, and could come as early as today (Wednesday).
If the deal is completed it will close the 18-month long negotiation that began with a $45 billion merger offer on February 1, 2008. The details of the deal will determine the bump in Yahoo’s share price, something investors really desperately desire.
Here’s what the deal may look like (from a Thomas Weisel Partners analyst report colorfully titled BingHoo! earlier this evening):
Deal (Finally) Inked: After a nearly three-year mating dance, Microsoft and Yahoo have agreed to a joint venture. The official announcement (hopefully with the financial implications) is expected tomorrow, July 29, the day before Microsoft’s annual analyst day.
Bing becomes the algorithm: Importantly, Bing is expected to become the default search engine for Yahoo, as it has become across Microsoft’s network since its launch in June. By combining both companies’ engineering talent, search indexes and ad platforms, Microsoft believes it can improve its ability to drive innovation in emerging areas such as video, mobile, and online commerce; all areas where Google is currently focused. The combined Yahoo-Bing search would have 28% share in the U.S. according to comScore. But combining search indexes and reorganizing a global sales force across two companies is not a trivial matter and a distraction that Google can take advantage of. It is unclear what the cost savings would be to Yahoo. A year ago Yahoo management (headed by former CEO, Yang) indicated outsourcing all of search would yield a $750mn annual benefit. Given this deal covers only the algorithmic side and Yahoo has been cutting costs over the past year, we estimate the savings would be less than half that amount.
Ad sales primarily owned by Yahoo: While details are still trickling out, it appears that Yahoo is slated to sell search inventory across both networks, capitalizing on Yahoo vertical strength in entertainment, finance and sports and Bing’s emerging strength in travel and retail. In addition Yahoo could gain the ability to sell display inventory across both networks along side search. The deal allows the parties to focus on core strengths: for Yahoo it’s selling and Microsoft it’s engineering.
No Upfront Payment—Where’s that “boatload of cash?”: The reported deal does not include an upfront payment to Yahoo, a previous element of prior proposals, which may mute upside in Yahoo shares. Several critical details have yet to emerge: like the revenue share agreement and split levels, renewal terms of the partnership, cost savings and ultimate ownership of the data. For example, if the search deal is an 80/20 split, Yahoo would cede about $400mn of 2010 revenue to Microsoft. In addition, we estimate that Microsoft generates about $2bn in annual display revenue. If Yahoo got to sell half of that at an 80/20 split suggests Yahoo could see $200mn in incremental revenue.
DoJ Scrutiny Risk: Importantly, the deal is likely to face a fair amount of interest from regulators regarding display advertising, which could delay the partnership by several months to several quarters.
The bottom line is, no one expects any upfront payments to Yahoo. Revenue split estimates range from 80% – 110% to Yahoo (higher in the beginning), and there is likely a hefty guaranteed revenue component so assuage the Yahoo board of directors.
This is a much different search deal that Microsoft offered Yahoo a year ago. From our summary of that long-dead offer:
Microsoft’s Last Offer
Microsoft last offered Yahoo a combination stock, asset and business deal that sources with knowledge of the situation summarize as follows:
Microsoft to acquire 16% of Yahoo’s outstanding stock from existing stockholders for $8 billion, or $35/share.
Microsoft to acquire all of Yahoo’s search and search marketing assets – servers, code, advertisers, third party publishers, intellectual property and employees (perhaps 3,000 of them) for $1 billion in cash plus a guaranteed CPC rate that is higher than what Yahoo can generate itself.
Yahoo gets increased search revenue from the deal over what they generate now, and get to remove people and operational costs of search.
Yahoo agrees not to touch the search or search marketing businesses directly ever again. All their searches are controlled by Microsoft.
We’ll analyze the actual deal terms as they are announced, but our guess is the likely outcome of this is one big complicated mess. The result: Google will take even more search share. Why these two companies don’t just merge is beyond me – everyone we’ve spoken with says everyone, on both sides of the table, would prefer a merger. Everyone, that is, except Microsoft CEO Steve Ballmer.