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Saying boo to Micro-hoo: Eric Auchard

July 29, 2009

Eric AuchardLONDON, July 29 (Reuters) – There’s been a bonfire of shareholder value at Yahoo and the blaze is not out yet, even after the agreement to a long-delayed deal with Microsoft.

Eighteen months ago, Yahoo walked away from Microsoft’s nearly $45 billion acquisition offer — a 60 percent premium to Yahoo’s then market value.

Fast forward to today and there is a zero premium being offered by Microsoft. And that’s after Yahoo also spurned $9 billion from Microsoft to buy just Yahoo’s search business. Still, investors had been hoping Microsoft might pay at least $1 billion in up-front cash to Yahoo.

No chance. Instead, Yahoo is receiving face-saving revenue guarantees for search advertising sold on Yahoo’s own sites for the first 18 months after the Microsoft deal takes effect.

Think ahead to 2012, the Olympics. That’s when Microsoft and Yahoo expect to finish fighting for regulatory approval, closing the deal, dividing up assets, putting their plans into effect and re-launching services.

The agreement is not an acquisition, but for Microsoft, it might as well be, as it gets control of the key levers.

For Yahoo shareholders, it’s value destruction not seen since the misguided merger of America Online and Time Warner at the peak of the dot-com era. The parallel between what is happening to Yahoo and the decline of AOL is instructive.

When the AOL-Time Warner deal was announced in 2000, AOL was valued at $166 billion. Four years ago, AOL was considered to be worth $20 billion. Now it’s less than $6 billion.

Yahoo’s stock market valuation hovered at just over $20 billion on Wednesday following an 11 percent decline in its share price that reflected disappointment at the terms of Microsoft’s pact.

And there’s no certainty Microsoft and Yahoo can win regulatory approval without big sacrifices.

The world has moved on since Microsoft first approached Yahoo. Google looks stronger, which might help the Microsoft-Yahoo case. But there are lots of lawmakers in Washington, not to mention Brussels, looking to write tough new laws to capitalize on consumer privacy fears.

Colin Gillis, a financial analyst with Brigantine Advisors in New York, argues the deal could be the trigger for a broader U.S. privacy law that seeks to rein in online behavioral targeting.

Among the major Internet advertising companies, Yahoo has been the most aggressive proponent of efforts to link user activities across the Web with targeted advertising. Pushing the Microsoft deal could prove damaging to its underlying ad strategy.

Terms of the deal give Microsoft effective control over Yahoo’s search technology, which will be incorporated into its own effort, Bing. In exchange, Yahoo will act as the sales force for the display advertising business of the two companies.

The danger for Yahoo shareholders is they will wake up in 2012 to find themselves owning a shriveled piece of the Internet pioneer’s former glory. A far leaner AOL, meanwhile, will be competing directly with Yahoo’s media and advertising businesses.

Web search is the most dynamic aspect of the online advertising market. It’s the best way advertisers have of figuring out consumer intentions. Microsoft ends up capturing search, while Yahoo retains the lower margin, labor-intensive job of selling display ads like site banners to other publishers.

In the end, Microsoft gets half of what it wanted and Yahoo has nothing more to show for the fight but something like $500 million a year in operating income when all the pieces are in place.

The new deal has a logical operational structure where Microsoft manages technology and Yahoo sells. But the value that’s being created will increasingly fall to Microsoft, when, years from now, the partnership comes into effect.

– At the time of publication Eric Auchard did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. To read some of Eric’s previous columns, click here  –

(Editing by Martin Langfield)

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