Internet Search Battle Heats Up

By Investopedia Staff | July 28, 2009 AAA

On Wednesday, tech giants Microsoft (Nasdaq:MSFT) and Yahoo (Nasdaq:YHOO) announced that they had agreed on a new internet search partnership. The new venture comes a year after a failed attempt by Microsoft CEO Steve Ballmer to buy Yahoo for a reported $47.5 billion. The new deal is for a 10-year term that will see Microsoft's new Bing search engine provide the search platform for Yahoo search in an attempt by both parties to close the gap in the internet search market, which Google (Nasdaq:GOOG) currently leads by a wide margin. While news of the deal sent shares of Yahoo plummeting down over 10% in the hours following the announcement, I like this deal for all the parties involved, including Google.

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The New Deal
Although all the particulars of the deal are not crystal clear yet, what we do know is that the 10-year deal will see Yahoo using the Bing search engine on its sites, while Yahoo will handle premium search advertising and Microsoft will continue to use its automated auction process to determine advertisers for automated search. Both companies will share the advertising revenues, with Yahoo receiving 88% of the revenues earned on its sites for the first five years of the deal. These revenues should add an estimated $275 million to Yahoo's annual operating cash flow and ensure that cash stream for at least five years, which will aide the company in growing its popular web media sites, such as Yahoo Finance and Sports.

Microsoft, on the other hand, will triple its search engine exposure by way of the agreement and will aim to pick up significant market share from Google going forward. The best part of the deal for Microsoft is that no cash will be paid to Yahoo up front, allowing Microsoft to hold large reserves on its balance sheet and maintain a strong cash position going forward.

Bad News Or Buying Opportunity?
Microsoft shares took a beating last week after the company announced fourth-quarter earnings that saw profits fall 29% and revenue slip 17%, halting the momentum the company's stock had seen following the introduction of Bing. Microsoft shares were pretty flat following the announcement, probably due to investor uncertainty over the partnership deal, but I would be very surprised if Microsoft shares didn't see a nice run in the next couple of months leading up to their next earnings announcement. Yahoo had also seen its shares recover nicely prior to Wednesday's announcement; they were up over 40% year-to-date before taking a beating immediately after the news was announced.

Investors were apparently unimpressed with the deal, and Yahoo was hit with a sell-off. I see this as a knee-jerk reaction by investors, making Yahoo a real buying opportunity. In the wake of Michael Jackson's death, Yahoo proved that its media sites were the go-to place for online breaking news; simply put, Yahoo's web media model is one of the best. The increased advertising revenue from the partnership with Microsoft alone should allow Yahoo to build upon what already is a great business model.

Google's Take
Many analysts see the partnership as a real danger for Google, and as far as search engine market share is concerned, they are correct. Currently at just over two-thirds of the internet search market share, Google will have a tough, if not impossible, time growing those numbers. However, the number of new individuals entering the search market grows with every new day, so revenues should not be a problem for Google.

Just take a quick look at Google's business portfolio: i's plain to see that the internet darling is much more than a search engine. True, the vast majority of the company's revenues come from its search platform, but Google has also made great strides into a number of other industries, such as telecommunications with the Android mobile device and the revolutionary Google Voice. The new telecommunications software, which allows users to create a single number for all of their phones and make domestic and international calls at a deep discount compared to traditional carriers, could prove to be a smash hit in the U.S., and other companies are taking notice.

Apple
(Nasdaq:AAPL) recently refused to allow Google to distribute its Voice application via its app store. Although this puts a major roadblock on the growth of the service, it's clear that demand for voice could prove to be a huge revenue stream for Google. In addition, Google's continued work at producing a web-based operating system that may one day rival Microsoft's Windows franchise seems to be worrying the market leader in that industry, with Microsoft reportedly working on web-based software for the distribution of Windows. In my opinion, Google has the brightest minds in the industry and great leadership at the top as well. I would look for Google to continue its ascent to the top of the tech sector.

Bottom Line
The new partnership deal between Microsoft and Yahoo looks to be a win-win situation for both companies. Investors' sudden sell-off of Yahoo could provide a great buying opportunity for those willing to look past the initial figures of the agreement. As far as what it will mean for Google, I believe that although Google's search dominance will be challenged, the company is growing in other directions that should more than offset the loss in market share that they stand to suffer as a result of Microsoft and Yahoo's partnership. (For more, check out From Beads To Binary: The History Of Computing.)

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