Search no more

Yahoo/Microsoft: Yahoo has finally signed a deal with Microsoft. But dithering for a year and a half has hurt. Instead of selling itself for a chunky premium, the company has retreated from its core web search business, outsourcing it to the Redmond giant. This turns Yahoo into a company oddly reminiscent of internet also-ran AOL.

The agreement will boost Yahoo’s margins. It will receive 88 per cent of revenues from sending queries Microsoft’s way. And it can cut spending on everything from engineers to servers. The company says the agreement should generate $500 million in annual operating profits and reduce capital expenditure by $200 million.

But look what Yahoo gives up. Microsoft has locked up its search traffic – the company’s primary charm. There’s now little reason for Microsoft or any other firm to buy the entire company. And Yahoo didn’t even receive any cash up front for signing the agreement. Its shareholders squawked, sending the stock down 12 per cent.

While Yahoo seems to be getting the short end of the stick, boss Carol Bartz had few attractive options. She took the top job in January, long after Microsoft abandoned efforts to buy Yahoo. And Google’s overwhelming dominance in search – it now controls about two-thirds of the market worldwide – put Bartz in a weak negotiating position. Outsourcing search might, in fact, be the best way to milk profits from the business.

So what’s left for Yahoo? The agreement doesn’t cover its email and instant messaging businesses. If Yahoo can develop these, it could sell more banner ads and derive more search-related revenue from Microsoft. But this is easier said than done.

AOL, for example, has tried nearly the exact same strategy – outsourcing search, enlarging its instant messaging business and developing content. It has had a rough ride. The price Google paid for a 5 per cent stake in AOL in 2005 implied that the internet firm was worth $20 billion. When Time Warner recently repurchased the stake, it valued AOL at about a quarter of that. Yahoo’s stock has plunged 52 per cent since Microsoft withdrew its bid last year. Emulating AOL’s strategy may not be the best way to stop that slide.