Microsoft Sees Financial Benefits, Tech Challenges in Yahoo Deal

Microsoft has painted its newly minted Yahoo partnership as the perfect vehicle for driving search and advertising revenue, while saving the company cash in the long term. However, Microsoft has also indicated that the transition will present challenges from a technical perspective.

During a July 29 conference call announcing the partnership, Microsoft CEO Steve Ballmer suggested that transition costs would run into the “couple hundreds of million in the first couple years. … We’re sort of betting into the future.”

Under the terms of the 10-year agreement, Microsoft will power Yahoo’s search engine with Bing, which it launched on June 3, while Yahoo assumes exclusive worldwide sales duties for the companies’ search advertisers. For the first five years of the agreement, Microsoft will pay TACs (traffic acquisition costs) to Yahoo at an initial rate of 88 percent of search revenue generated on Yahoo’s sites. Unlike Microsoft’s failed 2008 bid to purchase Yahoo for $44.6 billion, the new deal involves no cash up front.

Ballmer suggested that the partnership would increase the relevancy of Bing’s search results, as the search engine fed off the extra data produced by being the new search platform for Yahoo sites.

“Because ads are a part of being relevant,” Ballmer said, “[this could] increase the monetization on both the Yahoo and the Microsoft sites.”

He added, “Our upside comes as execution really builds,” but noted that the technological aspect of the partnership, particularly with regard to data-sharing, represented as complex a challenge as the financial principles.

“You have to say what data gets shared and how it gets shared from a privacy perspective, what APIs need to be equally open and visible,” Ballmer said. “There’s a lot of engineering know-how; we haven’t looked at Yahoo’s code, but we wanted to make sure we could put together the integrative experience and code.”

Nonetheless, analysts seemed generally approving of the deal’s implications for Microsoft.

Microsoft “can now focus on technology rather than on media and advertising, which is a more natural fit with its corporate culture, while still benefiting from the very scalable and promising new media business,” wrote IDC analysts Karsten Weide and Susan Feldman in a July 29 research note.

“It will be interesting to see Microsoft’s next moves with regard to its (considerable) display ad business” they wrote, “which will allow us to see whether the company will de-emphasize the media side of the business even more.”

Others suggested that Microsoft had dodged a bullet by agreeing to a partnership as opposed to acquiring Yahoo outright in 2008.

“The deal is a clear win for Microsoft, which receives the search volume it needs, without the risk and expense of a full acquisition of Yahoo, all for a fraction of the proposed acquisition price,” Allan Krans, an analyst with Technology Business Research, wrote in a July 29 research note. “In hindsight, the failed $45 billion bid for Yahoo may seem like a blessing, as Microsoft avoided both a large financial outlay [and] the myriad of issues that would have been faced [in] integrating a purchase of that scale.”

“Taking the operating income benefits estimated by Yahoo, this deal will cost Microsoft between $500 million to $1 billion annually,” Krans noted, “which pales in comparison to the proposed acquisition price, and is not significant given the spend rate in Online Services is already approaching $6 billion per year.”