May 1, 2002 4:20 PM PDT

Overture bows to Google in AOL deal

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America Online will use search services from Google, ending its relationship with Overture Services, the companies announced Wednesday. But Overture stressed that it still expects to see a strong quarter because of its recent deal with Yahoo.

Analysts had been closely watching the negotiations with AOL, a unit of AOL Time Warner. Microsoft and AOL together accounted for 40 percent to 50 percent of Overture's revenue in earlier quarters. In February, Overture announced that it extended its deal with Microsoft's MSN service for at least a year.

Overture's search engine allows advertisers to pay for placement in search results. It typically partners with portal sites, splitting the revenue. Although its pay-for-placement model helped it ride out tough times in the Internet advertising market, Overture still faces increasing competition, particularly from rival search engine Google.

Shares of Overture closed down $12.20, or nearly 36 percent, at $21.99 on the Nasdaq Stock Market. Merrill Lynch analyst Justin Baldauf downgraded Overture to "buy" from "strong buy," and other analysts said they were surprised by the demise of the AOL-Overture partnership.

AOL said its deal with Google would provide pay-for-placement search results for its AOL, CompuServe, AOL.com and Netscape Communications properties starting this summer. The companies did not provide details about the multiyear deal.

As part of the deal, Google will also replace Inktomi as the proprietary search engine on AOL's network of sites, effective in August. This ends a nearly 3-year relationship between AOL and Inktomi in Web search for AOL's U.S. and international properties. Inktomi will continue to provide content-networking services to AOL.

Overture said its deal with AOL's Netscape unit would phase out by August as well. Its contract to provide search services for the AOL and CompuServe services, as well as AOL.com, was set to expire Wednesday.

The company will continue to provide search results for AOL's properties in the United Kingdom, France and Germany under a multiyear deal signed in January.

Overture CEO Ted Meisel said in a conference call Wednesday that AOL was "far from our largest partner."

"We view AOL's decision as a minor setback," he said.

Overture: Revenue on course
Surprising Wall Street last week, Overture posted a profit of $29.3 million, or 48 cents per share, for the first quarter and announced a three-year extension of its deal with Yahoo.

Overture did not say in its statement what effect the termination of the AOL deal would have on its finances. The company did, however, reiterate revenue estimates for the second quarter, adding that because of a $2 million change in tax provision estimates it now expects to see net income of $14 million and earnings per share of 23 cents. That compares with a previous outlook of $16 million and 27 cents per share, respectively.

The company also raised estimates for the full year, largely because of the Yahoo deal. The company now says it expects to post revenue between $530 million and $570 million for 2002, up from previous estimates of $473 million. The Pasadena, Calif.-based company also expects to see a profit between $60 million and $65 million, or between 97 cents per share and $1.05 per share, compared with a previous outlook of $58 million, or 94 cents per share.

Analysts were mixed on Overture's future prospects.

"The Yahoo win more than offsets the AOL loss," wrote Goldman Sachs analyst Anthony Noto, who reiterated his "recommend" rating on the stock and raised his earnings estimates for Overture on Wednesday.

"The AOL deal does not change our growth projections or valuation perspective...We viewed the AOL deal as an option, not a risk," Noto wrote. "Overture's leadership position and traffic acquisition costs are unchanged."

But other analysts weren't quite as optimistic.

Merrill's Baldauf said the loss of the AOL deal will begin to hurt Overture's financial results in 2003. Overture projected 2003 earnings between 53 cents a share and 83 cents a share, slightly lower than projections from research firm First Call. Revenue, however, will be above estimates at $640 million to $690 million for 2003.

Those targets imply that Overture's profit margins are likely to take a hit because of competition from Google, Baldauf said. "We believe that uncertainty about long-term margins due to competition from Google will likely limit opportunities," he said.

Troy Mastin, an analyst at William Blair, pointed out that many analysts had expected the deal between Overture and AOL to be renewed. The fact that it wasn't probably "was not due to a lack of interest on either party's part," he said.

However, Mastin said that based on Overture's new fiscal 2002 projections, it's likely that "the economics of the Yahoo agreement are more favorable than the balance of the company's affiliate arrangements."

Overture's Meisel said the loss of the AOL deal was not necessarily tied to financial concerns or to a head-to-head comparison between the pay-for-performance services offered by Overture and Google. Rather "we believe it represents an attempt (by AOL) to capitalize on Google's search brand, and pay-for-performance merely came as part of the package," he said.

That prompted some analysts to question whether Overture should look into offering its own algorithm-based search services. Meisel said the company has no immediate plans to offer such a service, although he did leave the topic open for the future.

"What we're seeing is a little bit of a movement in the market to see whether companies prefer to work with a branded player or an unbranded player, as much as algorithmic or not," Meisel said. "We feel good about the deals that we've got with Lycos, Yahoo and MSN. We will continue to evaluate whether that group of partners would like us to offer an algorithmic search or not."

Discussing Overture's financial expectations for 2003, Meisel said that the company was "leaving ourselves room for investment as the market evolves, either in this business or in adjacent businesses as the market demands."

Stefanie Olsen contributed to this report.

 

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