Wall Street's Reaction To The Microsoft-Yahoo Search Deal: Not Good

Carol Bartz and Steve Ballmer are all smiles this morning with the signing of their long-awaited search deal, but the agreement isn’t going over so well on Wall Street. Shares of Yahoo took a plunge this morning on the announcement and are currently trading at $15.31, down 11 percent from yesterday’s close. Microsoft shares are flat.

Investors who were hoping for a large upfront payment and “boatloads of money” were disappointed by the terms of the deal, which includes no upfront payment. But that is short-sighted of investors because the actual deal ends up giving Yahoo a much bigger share of search revenues (88 percent) than the previous deal that was on the table last year. It is actually a much better deal for Yahoo long-term if it works, and aligns its incentives closer to Microsoft’s.

If Yahoo were instead to realize more of the value of the deal upfront, it wouldn’t have as much reason to make the deal a success over time. This is a10-year deal. Making sure both sides are working towards the same goals for the next decade is pretty crucial, and a large upfront payment would have diminished that incentive because it would have come with a lower revenue-share for Yahoo on the backend. Microsoft CEO Steve Ballmer said as much on the conference call this morning when asked what the differnce was between this deal and the one offered last year.

The deal last year was tailored more towards an investor than an operator. This deal is different, not better. Less upfront payment, and definitely a higher TAC rate.

(The TAC (traffic acquisitions cost) rate is the percentage of search ad revenues Yahoo gets from the deal). Whether or not Bartz had a choice in the matter, taking the higher TAC rate over a “boatload of cash” will be better for Yahoo in the long run. Eventually, Yahoo’s investors will figure that out.