With Microsoft deal, Yahoo tosses in the search towel

When Yahoo Inc. agreed to team up with Microsoft Corp. to better take on search giant Google Inc., some analysts said they wondered whether the online pioneer mistakenly sold its soul in the process.

The 10-year Microsoft-Yahoo deal announced yesterday calls for Microsoft's new Bing search engine to power searches on Yahoo's various sites. That means Yahoo's own search technology will go the way of the dinosaur.

And looking down the road, analysts question what will happen to Yahoo once the deal is over.

The the new partnership could simply be the beginning of a long-term courtship that eventually leads to the merger of the two industry giants. But If the companies don't merge and the deal isn't renewed, what happens to a Yahoo that has no up-to-date search technology?

That, says Karsten Weide, an analyst at research firm IDC, is a big question. And one that leads him to believe that Yahoo has made one heck of a big mistake.

“I was never in love with this deal, and I think it's a strategic mistake for Yahoo,” said Weide. “With something as important as search, you don't want to give away the technology you need to compete with everybody else. Once you've outsourced search, it will be almost impossible to get it back in-house after 10 years. This is really a pretty grave decision to make.”

Industry analysts aren't the only ones who think this could be a dubious move for Yahoo.

In stock market action Tuesday, Yahoo's share price dropped more than 11%, hitting $15.17. The stock's value had risen 20% over the past several weeks on speculation that a deal was brewing with Microsoft — and that the pact would include a hefty upfront payment. Such a payment, however, was not part of the actual deal.

Following a telephone conversation with Yahoo officials today, Weide noted that while the company will use Microsoft's search technology, it will handle design of the the user interface in-house. “What happens under the hood, they will give all away to Microsoft,” noted Weide. “[Yahoo] will retain [responsibility for] how the results are presented to the user. Some of the search engineers will stay [at Yahoo] to work on the user interface experience, some will go to Microsoft and some will be laid off.”

When Carol Bartz took over as Yahoo's CEO earlier this year, she made it clear that she was going to try to re-ignite the company and regain some of the hip buzz that surrounded the online pioneer in its early days. However, Bartz also was adamant that she wanted to clean up shop operationally and get costs and revenue in line. And this move falls into line with that part of her plan, analysts said.

Weide noted that, in the short-term, the deal does make financial sense for Yahoo. The company will retain 88% of its search revenue, only paying 12% to Microsoft for tech services. And, he said, Yahoo will save millions of dollars that no longer need to be spent on data centers and massive server infrastructures.

“They'll boost profitability, and [Bartz] needs to show to Wall Street that she's making this ship more profitable,” said Weide.

Jim McGregor, an analyst at In-Stat in Scottsdale, Ariz., said that if a merger with Microsoft is the final result, the move won't be such a bad one for Yahoo. “This kind of puts the two companies much tighter, where Yahoo becomes the advertising and services arm,” added McGregor. “If they're successful and hold their own in this market, five years out we're probably looking at one company and not two.”

However, if a merger isn't in the cards, Yahoo could be in a jam.

“Once you give up a key part of your business, it's hard to regenerate that,” said McGregor. “What you do is merge with your partner. And a 10-year deal is kind of unheard of in this industry. They didn't do this as a temporary thing. They did this as a permanent thing.”

He added that by putting all of its eggs in Microsoft's one basket, Yahoo became extremely dependent on Microsoft's continued interest in the partnership.

Ezra Gottheil, an analyst at Technology Business Research Inc., said Yahoo's big mistake was not accepting Microsoft's offer last year to buy the company for some $45 billion. “The bad deal for Yahoo was turning down the insane first offer,” said Gottheil. “Frankly, Yahoo wasn't going to be around at the end of 10 years without it.”