$1 Billion of Cash Flow For Yahoo-Google Search Deal? Keep Dreaming

Henry Blodget | May 7, 2008 9:37 AM

The second reason Yahoo's stock (YHOO) has rocketed higher in the past few days (the first being Hail Mary dreams of a Microsoft (MSFT) deal) is that investors are expecting a whopper of a Google (GOOG) search outsourcing partnership to be announced any day now. Specifically, the number everyone has latched onto, originally floated by Citi's Mark Mahaney, is incremental cash flow of ONE BILLION DOLLARS.

Keep dreaming.

At best, a Yahoo-Google search partnership will deliver a few hundred million to Yahoo's EBITDA. This would be a nice boost, but not the WOWZA!!! blow-out that the market is now expecting.

How do we know? Because that Mahaney $1 billion incremental cash flow estimate is based on the premise that Yahoo will:

Outsource 100% of its search business to Google
Fire everyone associated with its internal search business, thus savings hundreds of millions in costs.

In fact, Yahoo has stated clearly in recent days that it has no intention of getting out of the principal search business (see Sue Decker's interview on TechTicker), which means that it won't be firing everyone associated with Panama (or even anyone). Second, Yahoo and Google sources have also made clear that they are considering only a partial outsourcing deal, in which Google monetizes only a fraction of Yahoo's search queries. Thus, the revenue boost will likely be far less than most people expect.

Mark Mahaney's most recent note provides a range of Google-Yahoo partnership estimates. These range from $250 million at 25% outsourcing and $1.2 billion at 100% outsourcing. Importantly, however, we do not believe that these estimates take into account the fact that Yahoo intends to preserve its Panama spending. Put differently, we think that, to hit these numbers, Mark is assuming that Yahoo will still fire everyone associated with Panama (Mark--please correct us if we're wrong).

Even if Mark's estimates are just based on revenue, we would be surprised if Yahoo exceeded the $500 million in gains he is projecting on a 50% outsourcing case.

Also, don't forget that these gains are essentially one time--Yahoo won't grow search cash flow by an additional $500 million in 2009. And, more importantly, the partnership won't help stem Yahoo's continued share losses in search queries, which will make the Yahoo partnership less and less meaningful over time.

Bottom line: A partial Google outsourcing deal would be a smart move that would improve the company's near-term financial performance, but it won't be the bombshell game-changer the Street is looking for.

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46 Comments

Rav said:

May. 07, 9:47 AM

The street is looking at the potential value of this kind of arrangement. YHOO doesn't need to realize this value all in one shot. It can be incremental. If the max revenue improvement is about $1B, it could potentially be worth about $6 per YHOO share. The increased cash flow to YHOO can be deployed in new projects that can lead to further growth. The arrangement can begin as a partial outsourcing and then depending on the outcome of that and any anti-trust issues, it could lead to further outsourcing in future.

Henry Blodget said:

May. 07, 9:53 AM

That's fair. But based on most of what I've read, the Street is looking for an instant $1 billion adrenalin injection.

Henry Blodget said:

May. 07, 9:54 AM

Also, don't forget that the value of this partnership will decline over time, as Yahoo's query share drops. Or are you in the camp who believe that somehow Yahoo will magically stem this decline with, say, search assist?

yankini said:

May. 07, 10:05 AM

I don't think google deal is Yahoo's long-term plan. They have the open market ad-exchange (apex) coming out in third quarter. (BTW, I think this is one of the reasons why MSFT backed out since MSFT likes closed form and Yahoo wants open form. Yahoo has more than 500 cream-of-the-crop engineers working on it. If MSFT quashed the project, they leave). Yang can get wall street excited with this Apex until end of 2008. Hopefully the recession lifts by then.....

Henry, you should really look into this Apex. Imagine an exchange, like stock exchange, for ad market. They get GOOG, MSFT, AOL and everyone else bidding (if it works)

Rav said:

May. 07, 10:13 AM

Henry, based on the historical trends, no matter what YHOO does or doesn't do, its query share is going to decline over time due to natural monopoly in search and network effects. So the choice is either leave the money on the table by poor monetization or milk the current search share and deploy the additional income in the next big thing.

Thomas said:

May. 07, 10:21 AM

Hello Henry -

The comment from Bill Gates about pursuing an independent path sounds incredibly stupid, considering they (MS) has been doing this for the past 10 years - and hasn't made even a modest gain against Yahoo or Google. In my opinion, they can continue pouring money into the lost cause of MSN. They will probably regret not buying Yahoo... because if they don't do it now (and quickly, after all time is of the essence) and forge ahead, Google will continue to dominate.

CLOWN CONTROL said:

May. 07, 11:14 AM

Henry,

Rest assured, the "Street" is not as "research" analyst driven as it was in your Pets.com era. The idea that every YHOO shareholder is banking on $1bn of cash flow from the GOOG deal is wrong. In any case, I appreciate your capacity to transition from shitty analyst to shitty reporter.

CLOWN CONTROL said:

May. 07, 11:15 AM

risk:reward said:

May. 07, 12:05 PM

the goog deal is not the long-term strategy.

yhoo can do it without throwing in the towel on search.

the deal will boost revenue more then you think, henry. not all monetized queries monetize at the same RPS. due to yhoo knowing its users behaviors it can use google to fulfill a percentage of the queries that monetize at a higher rate.

for example, if yhoo lets goog fulfill 10% of the queries...the important question that NO ONE is asking is, 'which queries'?

10% of all queries or 10% of all paid queries (sponsored results)? huge difference to revenue.

and then within the paid queries bucket, it can be sliced much further to focus on the paid queries with the highest RPS.

rolonation said:

May. 07, 1:03 PM

This is based on my own searches as of late (I do about 25 queries a day, about a 100 to 150 a week), but I feel that Google's results are becoming less relevant to what I am looking for. Maybe its just my results that stink, but I have recently switched over to Yahoo! search to give them a try.

With Yahoo's new ability to search through my subscriptions (currently Lexis Nexis, the FT, and the WSJ), I like their positioning for the future.

You can tell that Google is getting further and further away from its core focus of search with all of its initiatives in Mobile, web apps, and communication, because their search results are starting to stink.

Just one man's personal opinion.

Seth Barnes said:

May. 07, 1:48 PM

Long term, Yahoo would be giving Google the keys to the kingdom. And many advertisers would be skeptical of Google controling an even greater portion of the market (even under a partial outsourcing).

Victor said:

May. 07, 2:06 PM

Google is in the driver's seat

piyush said:

May. 07, 2:10 PM

The recent rumor of Microsoft sending feelers to Facebook looks to me like another play of trying to flash alternate cards.

Me thinks Microsoft is coming back to Yahoo, if not next month, perhaps after four. At what price? Definitely lower than 33$.

Lets see how it goes.

Alex Schleber (URL) said:

May. 07, 2:20 PM

... this is why the exact "cash flow plus" dollar figure (if any actually comes to pass) is not nearly as important as the implied admission of

Alex Schleber (URL) said:

May. 07, 2:23 PM

oops, truncated

... this is why the exact "cash flow plus" dollar figure (if any actually comes to pass) is not nearly as important as the implied admission of how badly Yahoo has fallen behind in search monetization (and MSFT for that matter). The gap is at 60-80%. For the exact same attempt at serving a search ad! An equivalent would be for McDonald's to make an extra 80% more on every burger they sell vs. say Burger King. Sheesh...

Read more here:
http://businessmindhacks.com/post/micro-hoo-techcrunch-interview-with-citi-analyst-more-proof-its-a-bad-idea

don Johnson said:

May. 07, 2:36 PM

Interesting on revenues side, but not relevant. Msft will let Yhoo twist in the wind for a while, and the market's summer decline, which probably started today, will aid in the twisting. In a perfect world we should see a slow and steady decline on YHOO to the $22 area, but there will be many lies and false rumours thrown out there (some which I have read here) which will interrupt the slow and steady aspect. Sometime soon(1-3 months) depending on the overall market and month msft will bid again, probably when yhoo near $22 a share and bid $31-$32, but market conditions will affect these targets, oddly enough more than the actual deal (if terms are common sense thinking). One thing that everyone overlooks is MSFT is optimistic that if they combine the two search staffs they can develop something better than Goog (doubt it but ya never know). Seen plenty of other synergies mentioned but never this one, which is actually the ultimate possibility of this deal.

Robert said:

May. 07, 2:39 PM

Remember that Yahoo outsourced all of search to Google before. 2000 - 2004 to be exact. So such a move for search or another part of the business is hardly unprecedented. Only difference is Google is bigger now.

SearchDude said:

May. 07, 3:03 PM

The dirty little secret is that Google gets to decide what ads Yahoo search results will display, and will cherry pick the high rev/high performance ads for themselves, like they do in the AOL deal. That will temper the real revenue/query performance Yahoo will see.

Slightly more evil each year...

Danny Sullivan (URL) said:

May. 07, 3:11 PM

Could another reason the stock has stayed relatively high be because maybe Yahoo was undervalued at $19? And that maybe being in the #2 spot to Google -- and the fact that Microsoft can't buy its way into that spot -- might mean that Yahoo isn't a complete dog?

In terms of a "fraction" of Yahoo's queries being powered by Google -- I don't believe Yahoo's said that at all. Yes, Yahoo's made it clear they aren't getting out of the business -- which Silicon Alley Insider itself was making it seem like was the case only a few days ago despite that never having been said. But aside from the idea Google will be handling some queries, we have no idea what percentage -- or if that percentage is the high value queries that you might be able to get more out of -- and a number of other variables that none of the financial people will be able to predict.

Could it be that for Jerry Yang to walk into Microsoft with the threat he'd bail -- and knowing that he'd face upset stockholders -- he knows he can get a good payout from Google? You remember Google has given revenue guarantees to other partners that don't necessarily reflect how much they expect to earn. Google could easily offer to pay Yahoo say $1 billion over the next year. If they only make $500 million, Google goes Oops (like you know, with MySpace) and thinks to itself nice, it only cost us $500 million to screw up Microsoft's plans and to spy on all of Yahoo's traffic.

But go on, breakout the spreadsheets and keep trying to predict what Google might do. The only thing you can predict with them is that you can't predict them.

jenkins said:

May. 07, 3:19 PM

Danny,

When you strip out revenue from recent acquisitions Yahoo's growth is "dog-like".

Yo Momma said:

May. 07, 3:29 PM

Danny, yhoo has a forward PE of ~48. Are they growing at near that rate (48%)? Obviously there are more things to consider than PE/PEG but how is yhoo way undervalued in this market (or any market) at even $19?

Msft has a forward PE of ~17 which is well within their rate of earnings growth. The stock that's way undervalued is msft. The problem is that it's the most hated company in the universe but they continue to deliver impeccable revenue and earnings growth. Why people can't see this simple fact is beyond me. People seem to base their investment on some probability that msft will die to goog yet their continues to be zero proof of that happening if you look at the numbers (which haven't been this good since the late 90s).

Danny Sullivan (URL) said:

May. 07, 4:48 PM

Yo Mamma, I don't disagree with you at all. People may well underestimate the value of Microsoft based on what might or might not happen with Google -- in the same way they might overestimate the value of Google based on where it may or may not be able to go. Current earnings are only a part of the puzzle.

That brings me back to Yahoo. Microsoft clearly wishes it could be number two to Google, to the degree it was going to spend $40 billion plus to make it happen with Yahoo. Keep in mind, Yahoo would have gained little relatively speaking from Microsoft in the deal aside from a stock bump. It has merrily been holding the number two spot for some time and more strongly than Microsoft has managed to keep its number three spot.

Yahoo has value. It may be that Henry's right, and it hasn't dropped more because people were two days ago thinking a deal would still with Microsoft come or today thinking a boomer deal with come from Google. It could also be that people are thinking hmmm, maybe this company IS worth more than we thought it was a few months ago.

Certainly I've watched people completely assume the search game was between Google and Microsoft when Yahoo was the strong number two and deserving of far more credit than it sometimes has been given.

I certainly don't know the answers. All I can tell you is that assumptions of what Google might or might not pay Yahoo simply cannot be made with confidence by those outside. You don't have all the factors in hand. It is simply guesswork, and sometimes really bad guesswork.

Yo Momma said:

May. 07, 5:03 PM

Danny, fair enough. Clearly I'm at a loss. My worst predictions didn't have msft trading where it currently is. Apparently there are a ton of people (hedge fund managers) shorting this stock. I have no idea why...

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