Yahoo / Google deal – good move

In an award-eligible 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 company.

And today Yahoo and Google struck just such a deal. So I figured it worthwhile to take a look at what they’ve announced and what it means to Yahoo’s financials and future. It’s less worthwhile to write about it here, but what the heck.

Disclosures and street cred: I am still a Yahoo shareholder and picked more up on the tanking this afternoon. I am no longer a Microsoft shareholder. And I used to run a Google-powered web search product for what used to be a major Internet company. So AdSense for Search … I’ve been there.

OK, so what’s the deal? Most significantly, Yahoo is not shelving its own paid or natural search systems; they are simply bolting AdSense on to some or all of their search results page in the U.S. and Canada. AdSense becomes just another monetization route for Yahoo Search – if they can’t serve a valuable ad; just let Google handle it.

And maybe that’s a smart move. It might quell some of the anti-trust sentiment already swirling around the deal, and allows Yahoo to still tinker around trying to build a better search. On the “anti-trust” stuff, by the way, I’m still perplexed at what the issue here would be. Yahoo is entering in to a contract with Google, and other competitors from AOL to the New York Times have the same deal with Google. Google will have no ownership in Yahoo … just a contractual relationship. The companies said flat-out today that the deal is not an anti-trust issue, so we’ll see.

OK, so the financials. Yahoo says they expect to see an extra $800 million in annual revenue, so running the assumptions from my first piece ($80 gross RPM from Google; 75% rev share) alongside ComScore data suggesting Yahoo’s annual query volume – that comes out at right about 50% of searches being monetized by Google. Hey, a round number – and room to grow. Yahoo says Google is going to be serving the deeper “tail queries”, which makes a lot of sense. Yahoo probably gets good value for everyday terms, but there’s no way their base goes nearly as deep as Google’s.

But Yahoo says the $800 million in annual revenue will result in just $250 million – $450 million in incremental net cash flow.

That incremental cash flow is projected to be only 31% – 56% of gross revenue is an interesting projection. Assuming the AdSense deal is set up as Google usually does it, that $800 million should have very little operating expenses laid against it (maybe 10% in administrative / support costs), so I’m thinking Yahoo is going to use a lot of the Google revenue to increase investment in their own search and advertising systems while showing enough bottom-line benefit to hold off the wolves.

Based on Yahoo’s projections, the deal would boost annual revenue 11% from the last four quarters and net income between 24% – 42% depending on where incremental cash falls in their projected range. That … ain’t bad.

Project that out with Yahoo’s current stock P/E ratio and you get a suggested value of $29 to $33 a share. Thirty-three dollars a share … why does that sound familiar?

So if you believe Yahoo’s projections (Google has provided no guidance on what to expect), the company gets a lot healthier real quickly. And I’m inclined to think they have a good handle on what to expect and are providing good guidance.

The Google Effect is very, very real. Hooking up with AdSense is like turning on a money faucet if you have any decent level of search traffic. There’s no reason to believe Yahoo won’t see a tremendous Google benefit. There’s a lot more work to be done in Sunnyvale (let’s see Jerry step aside at the annual meeting for starters), but what Yahoo has shown Mr. Icahn, Mr. Ballmer and everybody else is they do have value to tap and selling out at a discount isn’t in the best interest of the company.

Update: Interesting conclusions can be drawn from Yahoo’s SEC filing on the Google deal. Google has a right to cancel the deal if it doesn’t end up pacing at $1 billion a year in gross revenue for Google; Yahoo projects $800 million a year in gross revenue to them – suggests an 80% rev share for Yahoo. Yep, that’s about right.

Also, the rev share will adjust based on “specified monthly gross revenue thresholds”. Google’s not going higher than 80% rev share, so I’m thinking Yahoo’s take goes down as monthly gross goes up. So Google is giving Yahoo the surety of the big rev share up front to shore up their earnings; then the benefit to Google is a higher take than usual once Yahoo has made its nut.

The “Change in Control” terms are also interesting:

As defined in the Services Agreement, the term “Change in Control” means (a) a merger, consolidation, statutory share exchange, recapitalization, restructuring or business combination involving directly or indirectly a party or a subsidiary of a party in which voting securities of the party outstanding immediately prior to such transaction do not continue to represent more than 50% (or 65% in the case of a transaction involving Microsoft Corporation (“Microsoft”), Time Warner Inc. (“Time Warner”) or News Corporation (“News Corp”), in each case together with their respective affiliates) of the voting power represented by the outstanding voting securities of the surviving entity immediately following the transaction; (b) any “person” or “group” becoming the “beneficial owner” (as such terms are used or defined in Sections 13(d) and 14(d) under the Securities Exchange Act of 1934, as amended) of more than 50% of the voting power of the then outstanding voting securities of the party, except that, in the case of Time Warner and News Corp, the percentage will be 35% instead of 50% and, in the case of Microsoft, the percentage will be 15% instead of 50% and a Change in Control will also be deemed to occur if Microsoft (i) beneficially owns 15% of the voting power of the party or (ii) acquires directly from a party any equity or voting securities of that party representing (or having a right to receive in the aggregate) 5% or more of the total equity value of the party or 1% or more of the party’s annual revenues on a consolidated basis); (c) approval by the stockholders of a party of a plan of liquidation or dissolution; (d) the sale or disposition of all or substantially all the consolidated assets of a party; or (e) at any point in time, Yahoo! no longer owns and, with respect to the U.S. and Canada, controls a majority portion of Yahoo!’s technology and intellectual property assets that in the 12-month period prior to that time had been owned by Yahoo! and used by Yahoo! to provide services in the U.S. and Canada for either its algorithmic search or search advertising business. The Services Agreement also permits Google to suspend performance of the Services under certain circumstances, including a pending Change in Control of Yahoo! involving Microsoft, Time Warner or News Corp and a change in a majority of the board of directors of Yahoo! following an annual or special meeting of stockholders if a majority of the new directors did not serve on Yahoo!’s board immediately prior to such stockholder meeting and were nominated or solicited for by Microsoft, Time Warner or News Corp or, solely with respect to Yahoo!’s first two annual or special meetings held after the Effective Date where the election of a majority of directors is before Yahoo! stockholders (but not later than September 1, 2009), by any other person or group.
If the Services Agreement is terminated by either party within 24 months of the Effective Date as a result of a Change in Control of Yahoo! (other than a Change in Control triggered only by Microsoft either (x) acquiring beneficial ownership of voting securities representing more than 15% of the voting power of outstanding Yahoo! voting securities or (y) acquiring directly from Yahoo! equity or voting securities representing 5% or more of Yahoo!’s total equity value or 1% or more of Yahoo!’s consolidated annual revenues, unless Microsoft becomes the beneficial owner of more than 35% of the voting power of such securities within such 24 month period), Yahoo! is required to pay to Google the sum of $250,000,000, which payment will be reduced by one-half of an amount equal to (a) all gross revenues received by Google pursuant to the Services Agreement through the date of termination less (b) the amount equal to Yahoo!’s share of such gross revenues during the same period.

Lots of financial legalese up in there. Specific references to Time Warner and News Corp. are interesting, as is the reference to Yahoo not owning its search business anymore.

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2 Responses to “Yahoo / Google deal – good move”

  1. Smoove D says:

    In an effort to monetize clickstreams, leverage synergies, and enhance the bottom line through building a market driven client focused knowledge based blog, I added Adsense to the Prizz. It would be nice if the ads were relevant once in a while. Also several appear to be the next frontier in spam (several hawking adderall have shown up recently). Yahoo would be wise to invest their windfall from Google in coming up with actual decent ad system.

  2. Cap'n Ken says:

    Just a disclosure – YHOO stock popped 11% today, and I took the opportunity to make a small profit on the shares I recently picked up and close out my position. Simply put – as Extraface says – Yahoo is like the crazy girlfriend. I know she’s nuts, but she can be a lot of fun. In the end, though, the downside is more dangerous and frustrating than the sex is good. So today was an opportunity to do her one more time and end it.

    And my prediction is that the stock will keep going up. That’s what always happens when I get out of something.

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