WASHINGTON Google Inc pulled out of a search advertising partnership with Yahoo Inc due to regulatory objections, causing Yahoo shares to rise as investors hoped the move could lead to a resumption of deal talks with Microsoft Corp.
Yahoo denied rumors it was in talks to sell itself to Microsoft for between $17 and $19 a share but its shares were over 8 percent higher. "Not true" said Yahoo spokeswoman Tracy Schmaler, who also denied a rumor that Yahoo CEO Jerry Yang was on his way out.
The U.S. Justice Department said on Wednesday it had told Google it planned to file a lawsuit to block the deal, under which Google would have placed its more lucrative ads on Yahoo searches.
"Had the companies implemented their arrangement, Yahoo's competition likely would have been blunted immediately with respect to the search pages that Yahoo chose to fill with ads sold by Google rather than its own ads," the government said.
Yahoo regretted Google's decision, saying it was "disappointed that Google has elected to withdraw from the agreement rather than defend it in court."
Between them, Google and Yahoo had more than 80 percent of the web search market in August, according to comScore Inc.
Microsoft had lobbied hard against the partnership which Yahoo initially struck with Google as a way to fend off an unsolicited takeover bid from Microsoft.
"They didn't want the Yahoo-Google deal to go through because they wanted to be in control of Yahoo's assets instead of Google being in control," said Youssef Squali, an analyst at Jefferies & Co.
Yahoo shares were up 8.5 percent to $14.49 in afternoon trading while Google was down 4.3 percent at $351.18. Microsoft was down 3.6 percent to $22.68. All three trade on Nasdaq.
"(Yahoo) investors are reacting favorably to the news (that the Google deal is off) as it might open the door to a possible deal with Microsoft, including a possible outright takeover of Yahoo," said Frederic Ruffy, options strategist at New York-based Web site WhatsTrading.com.
Google and Yahoo, Nos. 1 and 2 in the Internet search market respectively, announced the planned partnership in June but delayed implementation to allow the Justice Department to review it.
Google said it pulled out of the deal rather than face a protracted legal fight.
"After four months of review, including discussions of various possible changes to the agreement, it's clear that government regulators and some advertisers continue to have concerns about the agreement," Google legal officer, David Drummond, said in a blog posting.
"We're of course disappointed that this deal won't be moving ahead," he said.
A source close to the deal said that Microsoft's decade-plus-long legal battles with the Justice Department over antitrust matters had been a lesson for Google. "Most observers would say that they (Microsoft) did allow themselves to get distracted," the source said.
Advertisers hotly opposed the search partnership, arguing that Google and Yahoo's dominance of the market could mean they would raise prices. But the source said regulators were more concerned that Yahoo "over time would become overly reliant on our system and would over time exit the search market."
Squali, the analyst at Jefferies & Co, said some sort of deal with Microsoft now seemed inevitable.
He said it was unlikely that Yahoo could grow organically and deliver high profit margins. "(It's) not in the picture right now," he said.
Yahoo could have gotten cash by selling its Asian assets, but Squali said it was unlikely given the state of the capital markets.
Needham & Co analyst Mark May said Yahoo remaining independent was the "worst possible scenario" for the company.
Sources have told Reuters that Yahoo is in talks about buying the content and advertising operations of Time Warner Inc's AOL unit.
(Additional reporting by Anupreeta Das and Doris Frankel)
(Reporting by Diane Bartz; editing by John Wallace and Tim Dobbyn)