Brilliant Yahoo-Google Move Bolsters Case For Higher Takeout Price

ANALYSIS: The Yahoo-Google search test is a brilliant counter-move by Yahoo. Not because it is a credible "Microsoft alternative"--it isn't--but because it should allow Yahoo to extract a higher price from Microsoft.

This search test won't block a Microsoft deal, and neither would a full-blown Yahoo-Google search partnership. But if the test works well, it will bolster Yahoo's argument that Yahoo worth considerably more than Microsoft's current bid, by holding out the promise of increased revenue and reduced cost from a full-blown outsourcing deal (analysts estimate that the benefits to Yahoo could be as much as $300-$500 of incremental EBITDA). And Yahoo has already lost the search game anyway, so such a partnership offers little risk to Yahoo.

Meanwhile, as Microsoft's instantaneous response demonstrates, the partnership will scare the heck out of Redmond. With Yahoo in Google's search camp, Microsoft would become even more irrelevant in search (not to mention display). Unlike Yahoo, however, Microsoft would never allow itself to outsource search to Google, which means it would stay irrelevant in search forever (as its share of queries gradually approached zero). All of which means that, if Yahoo and Google appear headed toward a full-blown search deal, Microsoft needs to buy Yahoo even more now--if only because it will then be able to fire Google as Yahoo's search partner.

How will Microsoft respond? It will run straight to the antitrust authorities and scream that a Yahoo-Google search partnership is terrible for capitalism, consumers, innovation, etc. But if this test merely leads to a partnership in which Yahoo runs AdSense on its pages, it's hard to see why anti-trust folks would prevent such a deal. All Yahoo would be doing would be buying Google products and taking Google money, and Yahoo doesn't have enough share of the search market anymore for this single deal to constitute collusion between two companies who control the market (only one of them controls the market--and it will continue to, with or without Yahoo). From Yahoo's perspective, why should everyone else be able to live off Google when Yahoo! can't? This isn't like previous anti-trust examples, where, say, Microsoft pointed a gun at Dell's head and said "take IE or you don't get Windows."

Some legal experts do say that a Google-Yahoo partnership would be problematic (Senator Kohl has already promised to look into it), and, in any case, Microsoft would be able to make a lot of scary noise. Of course, if the test works, Yahoo will be able to demonstrate a big revenue lift, and Yahoo shareholders will be able to make a lot of angry noise about how Microsoft is paying way too little for the company in light of Yahoo's recently discovered revenue goldmine.

And this would leave the companies with only one graceful way out: Microsoft jacks its bid to at least $35 and Yahoo accepts it. -HB

NEW: Yahoo and AOL May Announce Merger Next Week (Don't laugh--just read it)

EARLIER: Yahoo's last-ditch effort to fend off Microsoft's takeover bid: A deal to test Google's (GOOG) ads on some of its search pages. Key points from the release:

- The test will only apply to some Yahoo.com search results in the U.S., not partner sites.

- The test will last up to two weeks.

- Fewer than 3% of Yahoo search results pages will display Google ads.

- The test doesn't necessarily mean that Yahoo and Google will form a broader deal. But they might.

This will make the situation with Microsoft hairier. But it shouldn't be enough to fend off Ballmer.

Microsoft has predictably slammed the deal, saying that any Yahoo-Google ad tie-up would make the Web ad market less competitive than its own deal for Yahoo.

"Any definitive agreement between Yahoo and Google would consolidate over 90% of the search advertising market in Google's hands," Microsoft said in a statement. "Our proposal remains the only alternative put forward that offers Yahoo! shareholders full and fair value for their shares, gives every shareholder a vote on the future of the company, and enhances choice for content creators, advertisers, and consumers."

Henry Blodget explored the possibilities of a Yahoo-Google search ad deal in February. See his post, "Outsourcing Search To Google Will Save Yahoo How?"

Yahoo (YHOO) shares spiked down 35 cents (~1%) on the initial news and recovered quickly. Closed at $27.77, up 0.25% on the day. Inching up and down in after-hours trading. More to come.

Full release text:

Yahoo! Inc., a leading global Internet company, announced today that it will begin a limited test of Google Inc.'s AdSense for Search service, which will deliver relevant Google ads alongside Yahoo!'s own search results. The test will apply only to traffic from yahoo.com in the U.S. and will not include Yahoo!'s extended network of affiliate or premium publisher partners. The test is expected to last up to two weeks and will be limited to no more than 3% of Yahoo! search queries.

As previously announced, Yahoo!’s board of directors is exploring strategic alternatives to maximize stockholder value, including exploration of potential commercial business arrangements. The Company noted that the testing does not necessarily mean that Yahoo! will join the AdSense for Search program or that any further commercial relationship with Google will result. The Company further stated that it would not comment on the nature or timing of any potential relationship.

Earlier coverage from WSJ, which broke the story:

The short-term test, involving a very limited percentage of Yahoo's Web search queries, is designed for the two sides to evaluate the revenue potential of a broader search ad outsourcing arrangement. They have been discussing such an arrangement as part of Yahoo's pursuit of alternatives to Microsoft Corp.'s unsolicited acquisition offer, according to people familiar with the matter.

The test under discussion, given its short time frame and limited scope, shouldn't stand in the way of any eventual sale of Yahoo to Microsoft, says the person familiar with the matter. But it could factor into the dynamics of the ongoing deal standoff, as a way for Yahoo to signal to investors its alternatives to the Microsoft deal and potentially as an irritant for Microsoft, which views Google as a major rival.

Smart analysis from PaidContent's Joseph Weisenthal: "...At this point, it can't legitimately be called an alternative route for Yahoo, given that it doesn't do what Microsoft's (MSFT) offer does -- namely pay Yahoo shareholders somewhere around $31 per share."

Details from NYT DealBook: The test is expected to last for two weeks and will only apply to U.S. users. Deal expected to be announced this afternoon.