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Google grows stronger in Microsoft-Yahoo fallout

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[June 14, 2008]  SAN FRANCISCO (AP) -- Microsoft Corp.'s abandoned takeover bid for Yahoo Inc. appears to have culminated with a disheartening thud for those two companies but amounted to yet another coup for online search leader Google Inc.

ChiropracticWhat began in January as Microsoft's most audacious attack yet on Google instead paved the way for the Internet's most powerful company to gain even more clout through a deal that gives Google access to a large chunk of Yahoo's advertising space.

By submitting to a partnership that endorses Google's search advertising technology as a better choice than its own, Yahoo is giving online marketers even more incentive to spend most of their money with its biggest rival, according to industry analysts.

It looks like such a sweet deal for Google that the U.S. Justice Department and lawmakers are expected to take a hard look at the arrangement to make sure it doesn't give Google too much control over the Internet's search advertising market.


Google currently has about 75 percent of the U.S. search advertising market followed by Yahoo at 9 percent, according to the research firm eMarketer Inc.

Although they contend their alliance won't lessen competition, Google and Yahoo have agreed to wait until late September to begin working together so the U.S. government has more time to assess the potential impact.

Even more importantly to Google, the Yahoo partnership keeps a potentially valuable weapon out of Microsoft's control.

Without Yahoo's renowned franchise, Microsoft once again is scrambling to find a way to fix its unprofitable online operations and narrow Google's commanding lead in the Internet's rapidly growing ad market.

Google shares gained $18.56 to close Friday at $571.51 while Microsoft shares added 83 cents to close at $29.07 - an indication that some investors were relieved the world's largest software maker concluded it would be too expensive and troublesome to buy Yahoo.

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On the other side of the fence, Yahoo shareholders had been clinging to the possibility that Microsoft would revive its last offer of $47.5 billion, or $33 per share, to buy the Internet pioneer. But those hopes evaporated late Thursday after Yahoo disclosed Microsoft had "unequivocally" rebuffed an attempt to renew the negotiations.

In a sign of investors' frustration, Yahoo shares dropped as much as $1.77, or 7.5 percent, Friday before rallying late in the session to finish at $23.47, down five cents. The downturn marked Yahoo's lowest stock price since it closed at $19.18 at the end of January, just before Microsoft launched its takeover attempt.

That leaves Yahoo's market value 29 percent below Microsoft's last offer, which was withdrawn May 3 after Yahoo asked for $37 per share. Yahoo's stock hasn't reached that price since January 2006.

At least Microsoft still has a strong, highly profitable backbone - a suite of software products that run most computers around the world.

Yahoo, though, may have made a Faustian bargain by hiring Google to show ad links next to a significant portion of the ad links appearing alongside search results on its Web site in the United States and Canada. The Sunnyvale-based company also will pluck Google ads to show on other Web sites in its marketing network.


Yahoo expects its annual revenue to get an $800 million lift from the arrangement with Google while still showing show the majority of its own ads alongside its own search results. But most analysts viewed it as an act of desperation, asserting it's only a matter of time before advertisers shift all their business to Google because they know their messages will show up on Yahoo either way.

Deutsche Bank analyst Jeetil Patel described Yahoo's decision to farm out advertising to Google as "one of the worst strategic maneuvers seen in the Internet industry."

Google will get such great access to Yahoo's highly trafficked Web site that it should be able to gather more insights about the correlation between search requests and advertising, ThinkPanmure analyst William Morrison wrote in a Friday research note titled "Giving Away The Store (To Google)."

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And that additional data could help Google further improve its advertising formula to become an even more compelling marketing magnet.

The partnership also cast doubt on a turnaround plan Yahoo co-founder Jerry Yang began drawing up year ago after he replaced Terry Semel as the Sunnyvale-based company's chief executive.

A big part of that strategy hinged on Yahoo becoming a "must-buy" for advertisers - a strategy that the Google deal appears to contradict.

"This raises very important questions about the long-term vision for (Yahoo) and its place in the industry," said Cantor Fitzgerald analyst Derek Brown.

Yahoo shareholders will get a chance to vent their frustration at the company's annual meeting Aug. 1 when activist investor Carl Icahn will seek to replace the board with nine alternate candidates.


Icahn was primarily interested in selling Yahoo to Microsoft, so his campaign to replace the board may be hurt if he can't persuade shareholders he has other viable ideas on how to boost Yahoo's stock price. He didn't return a call seeking comment Friday.

Yang and his top lieutenant, Susan Decker, defended the Google deal as a profitable move that will better position the company to capitalize on the Internet advertising market's growth from roughly $40 billion worldwide this year to a projected $75 billion to $80 billion market in 2011.

Microsoft contends it offered Yahoo a better alternative even after losing interest in buying the entire company.

When the latest talks broke off June 8, Microsoft was prepared to buy Yahoo's search operations for $1 billion and pay $35 per share to accumulate $8 billion worth of Yahoo's stock, according to an internal note sent Friday by Kevin Johnson, who oversees Microsoft's online operations.

Microsoft also would have offered guarantees that could have boosted Yahoo's operating cash flow by an estimated $1 billion annually, Johnson wrote.

Yahoo estimates the Google partnership will increase its operating cash flow by $250 million to $450 million annually.

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"Regardless of Yahoo's decision, we will continue to move forward on our strategy in online services and advertising," Johnson assured Microsoft employees.

Microsoft left the door open to renewing talks about buying Yahoo's search operations. Yahoo also gave itself some wiggle room by including a clause in the Google partnership that would end the alliance for a termination fee of up to $250 million.

Some analysts and investors still think Microsoft eventually might try to buy Yahoo in its entirety, although at a price well below $47.5 billion.

"Yahoo seems to have backed itself into a corner pretty effectively here so it would appear Microsoft has a lot of leverage," said Dan Davidowitz, a portfolio manager for Polen Capital Management, which owns about 750,000 shares of Microsoft and 37,000 shares of Google.

Davidowitz said he isn't interested in owning Yahoo's stock.


AP Technology Writer Jessica Mintz in Seattle and AP Business Writer Christopher Rugaber in Washington, D.C., contributed to this story.

[Associated Press; By MICHAEL LIEDTKE]

Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.



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