SAN FRANCISCO/SEATTLE (Reuters) - Microsoft Corp (MSFT.O) and Yahoo Inc YHOO.O inked a 10-year Web search deal to challenge market leader Google Inc (GOOG.O) but stopped short of combining their display advertising businesses.
The long-expected deal effectively means Microsoft’s new Bing search engine will be combined with Yahoo’s experience attracting advertisers to pose the first serious threat to Google, if the companies get regulatory approval and can make the partnership work.
Yahoo shares fell 11 percent as some investors were disappointed by the limited scope of the deal, which did not include upfront payments for Yahoo, which could have been $1.5 billion or more, according to a Sanford Bernstein research report last week.
“Microsoft will be able to report a greater share in terms of search... And Yahoo doesn’t have to spend any more money on search,” said Barry Diller, chief executive of IAC/InterActiveCorp IACI.O, which owns rival search engine Ask.com.
Shares of Microsoft were flat, while Google shares fell 1.2 percent.
Microsoft and Yahoo still face antitrust and privacy issues and likely opposition from Google, which dropped its plans for an advertising partnership with Yahoo last year under pressure from the U.S. Justice Department.
The companies said they expect the deal to be “closely reviewed” by regulators, but were “hopeful” it can close in early 2010.
Google said on Wednesday only that it was “interested” in the Microsoft/Yahoo partnership, while the chairman of the U.S. Senate antitrust panel said the deal warrants “careful scrutiny.”
The deal culminates a lengthy, and at times contentious, dance between the two companies. They have been in on-and-off-again talks on a search partnership since Yahoo rebuffed Microsoft’s $47.5 billion takeover bid last year.
Microsoft Chief Executive Steve Ballmer clashed last year with former Yahoo CEO Jerry Yang, who was strongly opposed to an all-out acquisition. Relations between the two companies improved under new Yahoo CEO Carol Bartz, who took the reins in January and started to shake up Yahoo’s top management.
Ballmer and Bartz met “three or four times” over the past six months as they hammered out a deal, according to Ballmer.
Under the deal announced on Wednesday, Microsoft’s Bing search engine will power search queries on Yahoo’s sites. Yahoo’s sales force will be responsible for selling premium advertising based on search terms for both companies.
Microsoft’s AdCenter technology will serve the standard sponsored links that appear alongside search results.
While Yahoo CEO Bartz had previously said that any deal would require a partner with “boatloads of money,” she said on Wednesday that the agreement provided “boatloads of value”, saying the revenue share agreement in the Microsoft deal was more valuable to Yahoo than a one-time payment.
“Having a big up-front cash payment doesn’t really help us from an operating standpoint,” Bartz said in a conference call with Microsoft CEO Ballmer.
Microsoft will compensate Yahoo through a revenue-sharing agreement that pays Yahoo at an initial rate of 88 percent of search revenue generated on Yahoo sites in the first five years.
Each company will maintain its own separate display advertising business and sales force, they said.
Analysts said it will be tough for the two companies to make a significant dent in Google’s dominance in search, but it was a step in the right direction.
According to comScore, Google has a 65 percent share of the U.S. search market, compared to Yahoo’s 19.6 percent and Microsoft’s 8.4 percent.
“Overall, it’s a big positive for two companies that have been struggling to keep up with Google. This consolidates their resources and allows them to make a more concerted push as the No. 2 entity,” said RBC Capital Markets analyst Ross Sandler.
Yahoo estimated the deal will boost its annual operating income by about $500 million and yield capital expenditure savings of $200 million. Yahoo also expects the deal to boost annual operating cash flow by about $275 million.
Yahoo reported income from operations of $13 million in 2008, hurt by $487.5 million in goodwill impairment charge and $107 million in restructuring charges. In 2007, operating income was $695 million.
Yahoo’s Bartz said that the deal will result in “redundancies” in Yahoo’s staff, though she declined to be specific. She stressed that any changes would not occur until after approval by antitrust authorities in the U.S. and Europe and full implementation of the partnership.
Shares of Yahoo were down $1.89 at $15.33 on Nasdaq, while shares of Microsoft were flat at $23.47. Google shares were down $5.13 at $434.72.
Additional reporting by Tiffany Wu, Paul Thomasch, Robert MacMillan and Diane Bartz; Editing by Derek Caney