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Tickers in this Article: YHOO, MSFT, GOOG
The three months ending June 30 was another soggy quarter for Yahoo! (Nasdaq:YHOO). That's no surprise - recessions tend to dampen advertisers' spending habits. But, while it's clear that Yahoo! is going to struggle over the coming quarters, this is no time for shareholders to throw in the towel on the stock.

Yahoo's Q2
Top line sales were in line with Wall Street estimates, but they were still in down 13% compared to last year's second quarter (8% after adjusting for foreign exchange fluctuations). Revenues from Yahoo's core display business dropped 14%, which is worse than Q1's 13% drop. Display ads are Yahoo's most important business, and it's not seeing any sign of a turnaround. Revenues from search services, meanwhile, fell 15%, compared to Google's (Nasdaq:GOOG) 3% increase in its latest quarter.
Things could be a whole lot better, but it's not as if Yahoo will be plunging suddenly into the red or rolling over any time soon. As a matter of fact, it's hard to find another media group - save Google - performing as well as Yahoo these days. The company's net income jumped 8% from last year to $141 million. Even more encouraging, the company produced $266 million in free cash flow in the quarter, up about 15% from the same time last year. To top it off, Yahoo! has $4.2 billion in cash and short-term marketable securities as well as zero debt.

Remember, Yahoo is one of the the world's most visited online destinations. It saw an increase of 7% page views during the quarter compared to the same period last year. According to media analysts comScore, last month its sites reached 151.2 million unique users.

Brandishing Brand Value
So, even as Yahoo gets pumelled by the economic downturn, the company is holding on to its termendous brand value - something that's highly sought after and could be exploited by a big tech partner. Can you say Microsoft (NYSE:MSFT)?

Indeed, recent statements from Yahoo and Microsoft, along with this week's launch of a revamped Yahoo homepage, hint that a long-awaited search deal could be in the works. On the Q2 conference call, CEO Carol Bartz went so far as to compliment Microsoft on its newly launched "Bing" Internet search engine. (Perhaps they've already struck a deal?)

The potential benefits of a search deal are pretty compelling. Cobbling together search operations for Yahoo and Microsoft would improve the quality of search results, attract more advertisers, shrink Google's market lead and most crucially, boost profitability. A tie-up that puts Yahoo in charge of Microsoft's display advertising business might be one way to a successful partnership. (For more, see 8 reasons M&A Deals Fall Through.)

The odds of a deal happening are pretty good. Steve Balmer, Microsoft CEO, has said that he is willing to dump another 5-10% of the company's operating income - or between $6 billion and $10 billion - into the search battle over the next five years. If Microsoft is as committed to search as it seems, Yahoo is likely part of its plans.

Bottom Line
A deal with Microsoft could be the share price catalyst that Yahoo Investors are waiting for. I'd say its worth betting on.

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