Why Yahoo Passed On Microsoft's Search Deal (New Details!)

Henry Blodget | June 13, 2008 3:00 PM

jerryyang4.jpgAs of last weekend, Yahoo (YHOO) had two deals on the table: A Microsoft (MSFT) search deal and a Google (GOOG) search deal. Yahoo chose the Google deal. After speaking with a person familiar with Microsoft's thinking and a person familiar with Yahoo's thinking, we now have a better sense of why Yahoo chose the Google deal.

According to the person familiar with Microsoft's thinking, the Microsoft deal was as follows:

  • Microsoft buys Yahoo's search assets for $1 billion. The search assets include: Code, people, servers, and data centers associated with both Yahoo's organic search (algorithmic) and paid search (Panama).
  • Microsoft and Yahoo enter into a search monetization agreement similar to the one Yahoo just signed with Google. In this deal, Microsoft would serve Yahoo's search results--organic and paid--handle the relationships with advertisers, and pay Yahoo a standard revenue split on each paid query. The main differences between this deal and the Google deal would be:
    • Microsoft serves both organic and paid results
    • Microsoft serves ALL Yahoo paid results (the Google deal is partial)
    • Yahoo discontinues any investment in Panama or organic search
  • Microsoft estimates that the combination of cost savings and revenue boost would drive $1 billion in incremental operating income to Yahoo per year. This is far more than the $250-$450 million expected from the Google deal. It is also, according to the person familiar with Yahoo's thinking, "a made up number" that depends on assumptions about how much cost Yahoo will eliminate. The person familiar with Yahoo's thinking says the incremental operating income from the Microsoft deal would be much lower than $1 billion. The familiar-with-Yahoo-thinking person also says that Microsoft's per-query revenue guarantee was lower than Yahoo is generating today and much lower that the Google deal will generate (i.e., lower revenue to Yahoo). The familiar-with-Microsoft-thinking person says, no, the deal guaranteed more revenue than Yahoo is generating [but not as much as Google.]
  • Microsoft buys 16% of Yahoo stock (existing shares) for $35 a share, or $8 billion. This would allow Yahoo shareholders to receive $35 for about 1 in every 6 Yahoo shares they own. It would not result in any additional dilution (or cash on the balance sheet) for Yahoo. The person familiar with Yahoo's thinking does not dispute this.

ANALYSIS

Financially, the main difference between the deals was that, in Microsoft's view, the Microsoft deal provided 2X-3X as much operating income and $1 billion of cash. TPFW Yahoo's thinking disagrees with the operating income assumption and views the $1 billion as chump change. If one takes TPFW Microsoft's thinking at face value, the Microsoft deal was the financial winner. Yahoo shareholders eager to get $35 for at least SOME of their Yahoo shares no doubt wholeheartedly agree with this.

Strategically, the Microsoft deal would have closed the door on Panama (no going back) and therefore provided Yahoo less flexibility. It also would have forced Yahoo to tell advertisers to book search campaigns using Microsoft instead of allowing them to sell search campaigns directly.

Operationally, the Microsoft deal would have freed Yahoo from having to worry about hiring and managing search engineers, as well as investing in search long term. This would allow it to focus 100% of its energies on display advertising. It would also have deprived it of control over a critical revenue stream and user product. The person familiar with Yahoo's thinking says this is a risk Yahoo simply wasn't willing to take (What would happen if the companies entered into a decade-long deal and Microsoft screwed up?

CONCLUSION

Yahoo decided that the strategic drawbacks of the Microsoft deal outweighed the potentially huge financial and operational benefits...and told Microsoft to take a hike.

Subscribe to SAI: RSS, email newsletter (no spam)

More:

Share:
Post to Del.icio.us


< Prev. Story
Next Story >

57 Comments

thomas said:
This certainly adds fuel to the fire of the existing shareholder lawsuits. Another indication that Yang would rather do 'anything but' any type of deal with Microsoft. It could also provide much needed ammunition for Icahn to oust the board... do i smell another shareholder revolt? Let's hope it holds until Aug 1.
Charles said:
Why would Yahoo! sell their search business for $1 billion if the company is worth $30 billion and the search revenue makes up 30-40% of the total revenue?
Why? Because they'd still get 90% (or more) of the revenue with none of the costs.

They wouldn't be selling the search window and eliminating search from the Yahoo site. They would just be outsourcing monetization, the same way they'll be doing with Google on a lot of queries.
temporal said:
Henry:

"And how were they ever going to separate the search business, anyway?"

I am glad you have seen the light of day now - surprised that you even thought such a deal was not possible!
Rav (URL) said:
I find it hard to believe that MSFT can monetize better and generate more cost savings than GOOG. The comparison that you are doing is not apples to apples and somewhat dishonest. If you really want to compare then use the same assumptions in both cases.

Assume that _ALL_ queries are outsourced to GOOG or MSFT and YHOO shuts down its internal search related development and support. In that scenerio, I'm sure the boost in YHOO operating income would be significantly higher with the GOOG deal. The $250-$450M they are talking about is based on long-tail which is hard for YHOO to monetize currently, and I'm sure would be hard for MSFT as well.

The way YHOO-GOOG deal is currently structured, eventually they would have flexibility to move towards the goal of full outsourcing, once all the regulatory hurdles are out of the way. So over the long run, GOOG deal would be less risky and a better choice compared to MSFT deal, in terms of monetizing the search share that YHOO holds.



florent said:
when it comes to yahoo leadership, why even ask why at this point? they are neither driven by logic nor advancing shareholders' interests. as they have proven time after time, they are unfit and need to be removed.

InTheFlow said:
Interesting - heard the search number was $9B, so at first thought the G2 you had was way off, but if I add the $1B and the $8B YHOO share purchase, the math works...

Think the info is reasonably accurate.

That means Jerry has some more splainin' to do!!! Yet another interesting deal they gave the quick kill to. Even on the call yesterday, when they talked about their direct interaction with MSFT, he thought it was a big deal that he could mention the ONE DAY over the last month that the chairman and others met MSFT directly - man, does that demonstrate openness to a deal or what?
Ananth Nagarajan said:
Henry,

"What would happen if the companies entered into a decade-long deal and Microsoft screwed up?"

Yahoo could have easily guarded against this by requiring Microsoft to make a guaranteed payment every year. They could have structured it such that this guaranteed payment increases at a certain rate over the next, say, 5 years. Of course, this is the minimum payment. Depending on traffic levels, the actual payment could be higher.

Note that Microsoft also wins by this deal. Even over 10-years, they would have paid just a fraction of the $48B they offered for whole of Yahoo. In return, they give themselves a decent chance of monetizing their search inventory at higher rates.

(Even if Microsoft loses say 500M every year, they would have still lost only 5B over 10 years. Big deal!)
Rav (URL) said:
The bottomline is this: MSFT wants to milk the YHOO cows without owning them (I believe analogy is Icahn's). GOOG wants to provide YHOO with a gadget that improves the yield of its cows. YHOO is free to use it on whichever cows they choose and on whatever days it suits, as long as GOOG gets a small cut, everytime they use this gadget. GOOG is very clear that they are not trying to own the cows or milk the cows.
yahoo said:
"Microsoft buys Yahoo's search assets for $1 billion. The search assets include: Code, people, servers, and data centers associated with both Yahoo's organic search (algorithmic) and paid search (Panama)."

What's the incentive for Yahoos to join Microsoft (which has no innovating ability, no scale, single-digit marketshare, monopolistic bullying nature that turns off advertisers)versus joining Google? Staying at "Yahoo minus Search" (which is really a media company)isn't what engineers are looking for. There are better media companies which haven't gone public yet (so we can get tons of stock options) unless MSFT wants search employees as POWs.
verde said:
@yahoo: the incentive is that you are actually a player in the search game rather than a [contractor/tool/bi---] for the leading player. nobody worth anything would work for yahoo in its new state, as the exodus of top managers makes clear.
Kev said:
A couple of points:

Yahoo's future in mobile and display ads greatly depends on intelligent placement, since screen real-estate is limited. This requires adeptness at inferring context, of which there is a tight correlation with search quality. Moreover, search infrastructure provides a huge and fresh dataset on which to experiment with learning algorithms. Neutering Yahoo would cause them to take too many steps backward.

Also, $1 billion for all of search and ad-related data centers/people/code seems like too low a number to make Yahoo happy. Some back-of-the-envelope numbers can be used to estimate the capital expense costs (quite possibly 100k machines). These would not be negligible.

Consider just data center requirements for search.
To provide web search with latencies of hundreds of milliseconds for thousands of queries a second, one wants to access the index from RAM, not disk. (Of course, we're probably right on the cusp of someone economizing things with super fast and super-cheap flash memory). Using that, one can get an order of magnitude estimate of the compute power needed for Yahoo search.

Per some dated press release, Yahoo indexes at least 20b pages, so let's give them the benefit of the doubt and consider only 1/5 being in memory: 4b. The average web page (html) is somewhere north of 100kb, so being optimistic about index compression, you might take a fraction of that: say 5kb. That's about 4x10^9 * 5x10^3 or roughly 20x10^3 gigabytes of memory, around 5k machines with 4-8gb of RAM a pop (probably standard for 2007-era setups). That's just for serving and doesn't include crawling or the most compute intensive parts of indexing and determining quality signals. Factor those in along with some redundancy and a search data center might have 10k machines. Now, multiply this by a small factor, as Yahoo probably has several of these setups replicated around the world, and you can realistically approach 50-100k machines for search.

Remember this is just an order of magnitude napkin calculation for just search. Ad-serving has its own set of requirements (almost search-like in itself) and is also compute intensive when it comes to learning all of the signals that were supposed to make Panama great; context-sensitive ad placement for YPN is another beast altogether. Considering this, it's not at all unreasonable for 100k machines to be part of that search/ad package.

Hundreds if not thousands of search engineers, a few data centers with 50-100k machines, and the thousands of years worth of labor developing the codebase and experimenting with all of the quality signals makes $1b look like a bargain price.
a yahoo said:
@verde: That's down right blanket statement (nobody worth anything would work for yahoo in its new state) its like saying blacks have no brains or men are better at Math. Majority of us want yahoo to stay independent with Search as main part. Believe me, there is a huge talent pool at yahoo. Management may not have done a good job but I guess they learnt their lesson (albeit little late)

Microsoft has money, talent and yet hasn't managed to gain as much market share as yahoo. So, what makes any one think that it will with Yahoo search code? It has a history of destroying companies after buying them. Do think Microsoft has better management than Yahoo does. if you think so, just look at their stock price for the last 5 years.
Paul said:
As a PPC advertisers on Google, Yahoo and MSN, there is no way that Microsoft could offer Yahoo greater revenue per search than they currently receive (unless they are taking a loss on ever search).
Tom said:
The $250-450 million of pre-tax cash flow Yahoo says it will generate from the Google deal is just in the first 12 months after implementation. If there is an $800 million incremental revenue opportunity in total, there is also the ability to generate very close to $800 million in incremental pre-tax cash flow from the deal.
verde said:
@yahoo: i totally respect your desire to remain independent. if you want independence (like you say you do), you should want yahoo leadership to stand and fight. but that's not the path yahoo leadership has now chosen. yahoo now serves at the pleasure of google. when it no longer pleases google, yahoo will be done. i have no interest in comparing yahoo vs. ms vs. google leadership. but i'd rather quit than work for a company that doesn't at least want to win.
ex Y exec said:
The strategic loss in the MS offer would expose Yahoo to a death blow across the entire product line. Y would be nuts to risk it.

That's the bottom line.
Alex Schleber (URL) said:
@Kev - for more real details on what it take to make search work, I highly recommend the following article on Google's data center operations which they just revealed to a greater extend a few days ago:

http://news.cnet.com/8301-10784_3-9955184-7.html

I really consider this required reading for anyone that wants to know what it really takes to get the things we take for granted to work.

Other than that, I agree with your and others' assessment that $1B is a joke for MSFT to offer for ALL of Yahoo's search team/hardware/business, favorable revenue share thereafter or not. Why would they want to unhand only the grand prize to MSFT and then have to rent the thing back from them?

Everyone also take note that the perception that MSFT cannot even match Yahoo's own monetization (let along GOOG's) per query is EXACTLY what I said on Henry's "Sock" post discussion last night. Almost VERBATIM.

This $1B/year extra revenue business is likely a pipe-dream. Compare that to Google's PROVEN monetization plus of 50-90% per query vs. Yahoo (form the Mahaney interview). If MSFT has the numbers to even beat Yahoo's own, let's see them. Where is the proof?

That Ballmer even for a second thought that this "offer" would fly shows two things:

1) How deluded and desparate MSFT really is at this point (not that much of a surprise given their recent appraisal of the Live Search Cashback gimmick as a "game changer"). [ As an aside, I occasionally have been checking LSCB price quotes against GOOG search results for identical items, and the FREE(!) product listings at the top of Google Universal Search beat the LSCB prices MOST OF THE TIME! ]

2) How much everyone is banking on investment only/no-tech-insight corporate raiders like Icahn to snap at the first whiff of money, regardless of the bigger picture unsoundness of the proposed deal(s).

For the record, YHOO today found a bottom at 22.50 and went right back to 23.50 at the end. Admittedly today was a rally day. I would think that if people digest this more rationally over the coming few days (reading and fully comprehending the drivel of the MSFT proposal is a start), the stock will firm up further.
hmmm said:
time for Brad G to come through with some more "Peanut Butter"...Right before the Aug 1 meeting

I wonder if he has any patience left or if he is gonna bail...

Joseph Hunkins (URL) said:
So, Yahoo turned down $40 last year, then $34, and now rejected a great revenue plan plus $35 for *some* of my shares, which all now sit under $24.

What, me worry?
curious said:
To all those shareholders who are angry that Microsoft or Yahoo did not make good decisions, I have a question. Why didn't you make the decision of selling the shares if they weren't performing well? Both MSFT and YHOO were going down every quarter before this MSFT-YHOO drama began. If you think the company isn't doing well, sell the shares. Monday morning quarterbacking is easier than being a quarterback.
Hyloka said:
@Yahoo! I think that the fundamental error in your thinking is saying that Yahoo! gained search share where Microsoft hasn't. Yahoo! started in the lead position, well before there was Google. Yahoo! through years of incompetence has lost more share than any other company in the search space. Microsoft, as is common, was late to the game and has only managed to eek out a small percentage of the search market, but I think that I'd rather be in the position of explaining why I was having a hard time against entrenched opponents who understand the market because they've been there years longer than explain why I was first, understood the value and piddled my lead away.
anyonewillbesillyasmsft said:
is the deal from msft really way better than google's one from yahoo point of view.
why
msft just bit every single query over google since it is open platform. it should help msft save a lot of money, but still have the same result.
Jamie Haas said:
Come on guys. This has to be totally obvious. Yahoo had no intention ever of doing business with Microsoft. Microsoft has been trying to cut deals with Yahoo for the past few years. They went public with the buyout attempt to show and force Yahoo's hand. Yahoo (Yang) and Google both see themselves as Microsoft competitors, Yang never had any intention of doing a deal with MS. If Microsoft gets Yahoo's carcass or Yang gets removed from his position, he'll be at Google for sure.
ladybug said:
yahoo should provide an offer to buy msn for 500M in the same way.
that is a way better deal than now , and also for msft.
thinking that msft could save 3B annual operation cost and also cash in query profit share.
Rav (URL) said:
Apple should make a bid for MSFT's (smartphone + OS + mp3 player) assets for 5B$ cash. This should include all OS assets including: Code, people, servers, data centers, patents, customer accounts, knowledge-base, buildings in redmond etc.

Combination of cost savings and revenue boost would drive at least $5 billion in incremental operating income to MSFT per year. Apple can then kill all flops like zune, vista etc. As part of this deal Apple should buy 16% of MSFT, using its high PE stock, hoping that some of the PE rubs off on MSFT stock. MSFT should discontinue all its investments in zune+xbox+OS as part of this deal. They can then focus all their energy in making Office work better as the primary goal for the new lean and mean organization.

The combination of the OS, phone and music player assets would unlock new R&D innovation, eliminate redundant engineering efforts and allow for greater scale in serving customers.

Taken together, I believe this proposal would create total value for MSFT’s shareholders in excess of $45 per share. Heck, just a single presentation by Steve Jobs could do this. Btw, its just an estimate, so don't hold me to it.

If MSFT rejects this unsolicited deal from AAPL, pundits can then start analyzing, how crazy it is for MSFT to have rejected this deal.
Frank T. said:
@Rav:

It seems as though you aren't familiar with the little friendly company we call Apple.

If you were, comments such as yours above would not exist... Please follow:

Apple is NOT a transparent company. Yahoo and Microsoft are. They are pretty much open books at this point. Apple works just like you'd think, (closed eco-system...including partnerships). For example, Intel's CTO LOVE, LOVE, LOVES Apple after the Macbook Air. But you don't see it all over CNBC. They have many more products lined up. But main stream media isn't covering it. Only Apple specific blogs have information such as this.

Anyways, your comments about Apple getting involved in such a pathetic cat-and-mouse game are insane. They never would. And thank god (or Steve..same thing?)

As much as I love Yang, Yahoo is toast. To top everything off, the search interface is a nightmare.

Thank you Apple for NOT getting involved in such low-brow bullshit. Thank you Apple for staying on neutral territory with industry GIANTS like Intel and chip makers that work on the cutting-edge of technology. Not old reptilian-run corporations led by salesmen. (Fucking Ballmer).

Either way, Apple would never get involved in any of this ridiculous nonsense. And as a person with a MAJOR position in AAPL. I am very glad.
Frank T. said:
After the insane post about Steve's health the other day. I've decided to only voice my opinion on this blog about Apple related matters and comment replies. My respect for this blog has been diminished tremendously since the last post about Steve's health. I have read many major posts from other blogs such as Gizmodo, MacBlogz, Engadget, iLounge, Macenstein, MacDailyNews... all of them, that refer to those headlines as being "immoral and under-the-belt." Well, I completely agree with the other bloggers. And to stand my ground and prove my point, I will defend Apple on this blog until proven wrong about any piece of information.

PS - Mr.Blodget- you're clearly a "headline-seeking-attention" blogger. I am asking you as a possible person you may cross paths with sooner than later, please keep your morals in tact. Thank you.
Rav (URL) said:
@Frank:

I guess it wasn't obvious. My comment was "tongue-in-cheeek". So, take it easy.. :)
FM said:
Where was the the YHOO BOD ! Yang has run YHOO into the ground to fend off MSFT. All BOD members should be personally held liable for this mess. Like Bernie Ebbers w/ WCOM, the courts need to set an example because the CEO's of BSC, MER, C, LEH, BAC et al have proven their egos come first and the BOD must be the last resort hope to tilt in favor of shareowner interests.
Alex Schleber (URL) said:
@Rav - priceless.

@Frank - did you really take Rav's comment seriously? He was just showing how ridiculous MSFT's "We'll-let-Yahoo-sell-us-their-search-division" proposal really is. I can't believe that MSFT had the chuzpah to even put this out there.

Either they are seriously deluded, or else these are simply low blows of the worst kind.
cleaning (URL) said:
Welcome to Nicolas Cleans OC!

We are a licensed and insured cleaning services provider.




Our friendly staff has been providing our Orange County customers with cleaning services for residential dwellings and commercial properties since 2003.

We specialize in providing affordable, reliable cleaning and maintenance services for:

+ Commercial: Office Buildings, Office Suites, Construction Job Site Clean-Up, Janitorial/Maintenance.

+ Residential: House, Condominium, Apartment, Rental Property, Vacation Property.

We offer flexible scheduling with competitive rates available for weekly, bi-weekly, and monthly service and maintenance, depending on your needs and budget.

Ask us about our 24-Hour cleaning services. We're available for around-the-clock service as needed!!!


--------------------------------------------------------------------------------

Do you have a question about our cleaning services? Please contact us by e-mail for more information. Or, call 949-573-1117 (office), or 949-842-7598 (cell/voice mail) to schedule a FREE CONSULTATION.
www.nicolascleansoc.com
thku4grace said:
All of this dialogue is interesting but not of much consequence now except as fuel for the class action lawsuit that's being drawn up by shareholders at this moment. As for Jerry, he doesn't seem to understand the meaning of fiduciary duty. The original msft offer should have been accepted for the benefit of company ownership. Neither of the other deals will amount to much compared to the 48B deal. Shareholder meeting in a couple of weeks--Jerry's toast! Yahoo stock did manage a little rally the last two hours of trading but that was after it was reported that msft was still open to more negotiation. We'll be revisiting the teens soon.
windrider said:
Yahoo paid $1B for Overture alone. I imagine they wouldn't want to give up all of search for that price tag.
kc said:
Its not all about money..I think yahoo should join Bill Gates foundation, time to go for charity.
sorry Y and MSFT said:
GOOG is so superior to Y and MSFT that none of this really matters. For all their effort (expense), Y search is horrid compared to GOOG (to visualize, think of a child competing with grown men). As for MSFT, no one likes or trusts them enough to use them for anything in which they have any reasonable alternative (hence all the software alternatives). Peoples reluctance to use MSFT wouldn't change if they bought Y. The only way Y will gain share is if MSFT bought GOOG, then all the GOOG-ites would go back to Y.
simlare said:
This m4v converter for mac supports converting M4V to iPod touch, iPod classic, iPod nano, iPhone, Apple TV, PSP, Creative Zen, iRiver PMP, various video mobile phones and many other digital video and audio players.
flv converter for mac supports set video output settings including resolution, frame rate, encoder, bit rate. Set audio output settings including sample rate, channel, encoder and bit rate.
charlie said:
mac dvd ripper
well ,we got this youtube video converter for youtube fans to convert.
wmv to mp4 converter can also help you put WMV files to your iPod, Zune, PSP these potable devices.
mov converter for mac is currently one of the best conversion software program.avi converter for mac
me said:
but it also means that you have enough information to use other resources, like internet people finders and online background checks. That means that you can find out almost exactly what you need to know, by starting with a reverse phone lookup.
selamler (URL) said:
chat
msn
Eric L. Prentis said:
With video cutte rfor mac,you can enjoy your favourite video clips at will.
With this easy-to-use m2v converter is designed to meet all your needs of converting M2V video format to other common formats.
marva (URL) said:
640-802 Why Yahoo Passed On Microsoft's Search Deal (New Details!) Thinks one way but acts another. She's so hypocritical. She thinks one way but acts another. Give me a chance please.
cal (URL) said:
That goes without saying. I did the best I could. 640-802 / 9L0-509 / 646-204 / 220-601 / 70-643 / 000-331
sesli chat (URL) said:
www.canimchat.com
guojijipiao (URL) said:
纳美旅游公司是华人知名公司拥有国际机票 ， 国际打折机票 ， 打折国际机票， 国际机票查询， 中美机票， 美中机票fgd .
fgghfd said:
guojijipiao said:

Join the discussion



Copyright © 2008 Silicon Alley Media, Inc. All rights reserved. Registration on or use of this site constitutes acceptance of our Terms of Service and Privacy Policy.