Microsoft / Yahoo – glad to see it’s (maybe) over

So last night Microsoft officially bailed on its offer to buy Yahoo. Jerry’s kids stuck to their guns on acceptable pricing and scared Ballmer away from a proxy fight with talk of a Google alliance. Well done, I say.

The only thing that would have made sense about this acquisition was a really big premium for Yahoo shareholders (I am one), and what Microsoft (I own it, too) was offering was a big premium on a stock depressed by a lot of missteps and the general decline in stocks over the past six months. YHOO was trading above Microsoft’s offer as recently as late October, you know.

It was an opportunistic move by Microsoft to snap up a battered company at its weakest moment. That Yahoo wiggled its way out of the Redmond Death Grip is impressive. In the short term, I’m sure Yahoo stock is going to get hammered, shareholder lawsuits will be filed and the pain of the Microsoft ordeal will linger a while.

But ultimately, Yahoo is much better off not being a subsidiary of Microsoft. Yahoo is a much, much stronger online brand than MSN (as represented by MSN.com, Live.com, Hotmail.com, MSNBC.com and whatever else makes up the mishmash of Microsoft’s online presence), and Microsoft is the poster boy for the futility of just throwing money at the Internet.

Microsoft has been growing its online business of late, and also growing its online losses. In the first quarter of 2008, Microsoft did $843 million in revenue and lost $228 million in their online segment. Yahoo, by the way, did $1.8 billion in revenue and made $121 million in the quarter.

Why, then, would Microsoft be a better owner of Yahoo? They wouldn’t. Microsoft just has plenty of cash on hand ($26 billion in cash equivalents) and thought they could pick up a great online asset on the cheap. And it would have been a hell of a nab for Microsoft, but ultimately “Yahoo – A Microsoft Company” would really sell short the Yahoo potential.

Having been a part of the kind of b.s. company outlook presentation Yahoo put together (PDF) to counter Microsoft’s advances, I don’t buy the “look how big we’ll be!” make-believe numbers, but Yahoo is right that the market under-values the company right now.

And the reason is this – all of the focus these days is on search advertising. Yahoo has poured a ton of time and money into their Panama ad platform with little effect against the Google machine, and that failure is what Wall Street has focused on. Microsoft, as well, has failed to put a dent in Google with its Live Search and AdCenter platforms.

Google has won web search as we know it. Period. Fighting that battle has been very bad for Yahoo, and it’s time to wave the white flag. With $50 billion in revenue and net income of $14 billion a year, Microsoft has the ability to continue the fight should they chose, but Yahoo needs to get out.

The logical move for Yahoo now is to syndicate Google AdSense for Search. Not outsource their search engine; just kill Panama and serve AdSense ads instead. An informed hypothetical effect of such a move:

- Say Yahoo now earns $50 per thousand queries (which is probably a high estimate) and their net margin after development costs, administrative costs, etc. of web search and Panama is 25% (what Google nets).

- Say using AdSense, Yahoo would see $80 per thousand queries (a reasonable estimate), get a 75% rev share (also a reasonable estimate) and have administrative expenses at 5% of their Google net. Then spend another 30% of that net on search engine development.

The Yahoo DIY model would net out $12.50 per thousand queries, while the AdSense syndication would net out $39.90 per thousand queries. Throw some conservatism into the estimates and it’s a safe bet that Yahoo could double its net search revenue while getting out of the losing game of chasing Google. Using my hypotheticals and ComScore search data, it seems plausible that Yahoo could add somewhere around $1 billion in net income per year just by getting (back) on board the Google train.

There is, of course, the anti-trust consideration. In a practical sense, Google (through its own site and its many, many syndication partner sites) currently has about 68% U.S. market share for search, with Yahoo probably holding about 23% – 24% with its sites and partners, and Microsoft picking up the remaining 8% – 9%. So if you’re arguing against a Google / Yahoo deal, you’d say essentially that Google would end up with 90+% market share. Of course, if you’re arguing against the deal, you’re probably Microsoft, which holds a 90+% market share in operating systems.

Adding Yahoo would obviously be a huge market share gain for the AdSense platform, but Google is already the ad provider for AOL (No. 4 in web search), Ask.com (No. 5), the web portals for Comcast, Verizon, AT&T, Cox and most other major ISPs, CNN.com, MySpace, NYTimes.com, LATimes.com, etc. etc. You get the picture – Google is web search advertising.

Would the Trust Busters really block a service agreement (not an equity stake) between Google and Yahoo because of AdSense market share concerns? Maybe, but it seems like a stretch to block a non-equity contract between two companies. Akamai is pretty dominant in the content-serving business, so are they going to be denied big new contracts because of “anti-trust” concerns?

I have to think the anti-trust hurdle is one Yahoo could clear on an AdSense deal with Google. The actual combination of the No. 1 and No. 3 display advertising companies and No. 2 and No. 3 companies in total online audience probably would have been a bigger anti-trust concern. And Yahoo’s long-held position as the king of online content is at the heart of its real value.

Even having lost a lot of luster during its “Hollywood” years, Yahoo is a stellar online content brand. Their future promise lies not in fighting Google, but in building online audience and monetizing well through display ads. If they had been focusing on that instead of chasing after movie deals and search advertising for the past several years, they would be in much better shape today.

When they’ve done smart things (like buying Flickr), they’ve managed to totally screw up integration after the fact. I guess they’re working on that now, but a real sharp focus is needed on re-crafting the Yahoo product set. The company was barely over its Semel Hangover when the Microsoft bid hit, so it’s going to take a while to really right the ship.

Once tightened up, Yahoo will be in a great position to fight the next online revenue battle – targeted display advertising that yields much higher CPMs. Google, of course, has taken note with its DoubleClick acquisition, and AOL is raising eyebrows with its Platform-A program.

Again, had Yahoo recognized earlier that search was lost, its focus could have been put on the next battle – one it was once in a dominant position to win. But Yahoo is about on par with AOL in terms of its display advertising network and dominates inventory on its own sites. Be smart, focus on the right things … and for God’s sake get a real CEO in there. Jerry Yang stopped being CEO the first time a year and a half before Yahoo reported having 155 employees (including 44 “surfers”) and generating $19 million in revenue. And he’s the guy to turn around a troubled $7 billion company? Please.

Yahoo is full of potential, but given their miscalculations and missteps over the last five years, their potential remains just that. The company could be the Google of Display Ads 2.0 if they start doing things right, or it might get picked up by Microsoft next year for half the offer they just turned down. I’ll be interested to see what the fate of Yahoo is now.

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One Response to “Microsoft / Yahoo – glad to see it’s (maybe) over”

  1. [...] and widely-ignored piece about five weeks ago, I detailed my unoriginal thoughts on a potential search outsourcing deal that could save Yahoo from collapse in the wake of Microsoft’s failed bid to buy the [...]

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