Digital Media

With Google deep-sixing its search-ad deal with Yahoo because of antitrust obstacles, what's next for the beleaguered Internet company?

Setting a new course isn't easy, of course, and Yahoo has less wiggle room without the the $800 million in annual revenue and $250 million to $450 million in new operating cash flow it said it expected during the first year of the Google deal. Now Yahoo has two basic options: continue with its internal efforts to improve its business, or enter into some sort of major transaction with the likes of AOL or Microsoft.

Judging by Yahoo's 5 percent stock price increase Wednesday, investors already had bid adieu to the money from Google and now are getting their hopes up for a major business transaction. Let's look at some of the possibilities for the company.

Deal?
AOL's online properties include a respectable display-ad business, a modest search-ad business currently powered by Google, and a variety of mainstream Web sites. But acquiring the company would hardly revolutionize Yahoo's business, and with all the overlap, integration would be complicated. What's appealing to shareholders about this prospect is the expectation that AOL parent company Time Warner would supply a good deal of cash--perhaps $2 billion by some estimates--while investing to take a major stake in Yahoo.

Microsoft is the more dramatic option, of course. With Yahoo's enfeebled stock price and Carl Icahn on its board, a Microsoft acquisition is still a possibility, even if Redmond has lost its earlier enthusiasm. But antitrust regulators showed some spine in effectively blocking the Yahoo-Google ad deal, and Microsoft already has a big red flag in Washington. By pooling their search-ad might, Microsoft and Yahoo still wouldn't catch up to Google, but the two might face criticism or resistance over merging their massive instant-messaging and mail operations.

Of course, the narrower acquisition of Yahoo's search-related assets would be a more manageable transaction. But given that Yahoo's search ad business was a relative bright spot in its third quarter, with graphical display ads suffering mightily at the hands of the economic turmoil, selling search would be hard.

Yahoo also has a number of assets in Asia it could sell. The falling stock market prices have diminished the value of those assets, but they're still considerable if Yahoo wants to find a buyer.

No deal?
After Google announced its decision to pull the plug on the partnership, Yahoo said it's focusing on improving its own core business--something it has to do regardless of whether there's a major business transaction.

Specifically, Yahoo called the Google deal merely "incremental" to Yahoo's plans, something that would have provided money to accelerate its plans but not something that changed "Yahoo's commitment to innovation and growth in search."

So what are those priorities? First is giving people a reason to go to Yahoo.

Here, Yahoo isn't so much concentrating on adding new properties as it is trying to get existing users to do more with Yahoo and to attract new users. Central to this push is Yahoo Open Strategy, an attempt to build social interactions into people's use of Yahoo, for example by sharing one Yahoo member's actions with his or her contacts. YOS also encourages the addition of third-party Web applications to Yahoo sites and the use of Yahoo data on others' sites.

YOS has the potential to fire up Yahoo's massive user base--142 million unique users from the U.S. in September, according to ComScore. But it's only being launched now, and it will take months for it to get up to speed, much less to win over Yahoo users and attract new ones.

The second big part of Yahoo's priority list is making money once users come, which for Yahoo, means advertising. But the market for display ads, the traditional graphical variety often used to promote brands, looks grim, and Yahoo's discussion of its involvement there involved a lot of optimism about positioning the company for growth once the market recovers rather than actual growth now.

Don't dismiss Yahoo out of hand, though, when it comes to advertising. The company has clout for online advertising, and it's just begun releasing a new technology called Apt that lets advertisers, publishers, and others join together at a larger scale for operations such as finding inventory where ads can be placed or selling ads for that inventory. Apt shows ads hosted by Google and by many hundreds of publishing partners.

A second ad factor for Yahoo is search. Most believe search ads to be less susceptible to recession-era spending cuts, and this business fared better in Yahoo's recent quarter even without a Google partnership. So no doubt this area is one of Yahoo's highest priorities. Google still dominates the search-ad market, though, and is making improvements of its own that gave it a downright rosy third quarter.

Google would have helped Yahoo's search-ad business, at least in the short run, by matching ads to search results where Yahoo's Panama technology couldn't. But the Google deal also illustrates the dangers of relying on your largest competitor for a major fraction of your revenue. The way the deal collapsed, with Google willing to scuttle it over Yahoo's objections, revealed that it can be hard to align competitors' priorities.

So, although Yahoo certainly isn't out of the woods and arguably is even deeper in, at least it isn't reliant on its rival's goodwill while choosing its next steps.

Google has pulled the plug on a search-ad partnership with Yahoo that would have given Yahoo major new revenue but that raised antitrust concerns.

"After four months of review, including discussions of various possible changes to the agreement, it's clear that government regulators and some advertisers continue to have concerns about the agreement," said David Drummond, Google's chief legal officer in a blog post Wednesday. "Pressing ahead risked not only a protracted legal battle but also damage to relationships with valued partners. That wouldn't have been in the long-term interests of Google or our users, so we have decided to end the agreement."

Updated at 7:35 a.m. PST: Yahoo isn't happy with the outcome.

"Yahoo continues to believe in the benefits of the agreement and is disappointed that Google has elected to withdraw from the agreement rather than defend it in court," the company said in a statement. "Google notified Yahoo of its refusal to move forward with implementation of the agreement following indication from the Department of Justice that it would seek to block it, despite Yahoo's proposed revisions to address the DOJ's concerns."

The deal's demise is a new blow to the struggling Internet pioneer, whose stock has plunged since Microsoft offered as much as $33 per share just months ago in an unfriendly acquisition attempt. Yahoo shares closed at $13.35 Tuesday, but rose 57 cents, or 4 percent, to $13.92 in trading Wednesday morning.

When Yahoo and Google announced the search-ad deal in June, Yahoo said it would generate $800 million and $250 million to $450 million in incremental operating cash flow in the first 12 months of operation.

Under the deal, Yahoo would have placed Google ads on some Yahoo search results, and the companies would have shared resulting revenue. The deal would have let Yahoo show ads on pages where its own technology, called Panama, wasn't able to provide results, the company said.

Updated at 7:51 a.m. PST: But the deal ran into objections, and the biggest was from the Justice Department's antitrust regulators. Today, those authorities expressed satisfaction with the demise of the deal.

"The companies' decision to abandon their agreement eliminates the competitive concerns identified during our investigation and eliminates the need to file an enforcement action," said Assistant Attorney General Thomas Barnett, who leads the Justice Department's antitrust division, in a statement. "The arrangement likely would have denied consumers the benefits of competition--lower prices, better service and greater innovation."

Other objections came from Microsoft, which runs in third place in search queries and search advertising after Google and Yahoo, and, perhaps more notably, from the Association of National Advertisers.

It's not surprising that Google and Yahoo didn't see eye to eye about how hard to fight for the deal. Google voiced its willingness to help out its chief business rival during a time when Microsoft was trying to acquire Yahoo and later, its search assets. Now, even though Yahoo's new board member Carl Icahn still is interested in a Microsoft transaction and many observers believe it possible, the Microsoft threat to Google is much diminished.

Also, from a raw financial perspective, Google would have benefited directly much less than Yahoo from the search-ad deal. Chief Executive Eric Schmidt said in October that Google typically gives the bulk of revenue to advertising partners that carry its ads.

Updated at 8:30 a.m. PST: Also, it's easy to see why Google might not want to fight this particular fight. No doubt Google, which already had a hard time pushing through its acquisition of display-ad powerhouse DoubleClick, doesn't want any more regulatory ill will than necessary.

And given Google's trajectory, more government scrutiny seems inevitable. Google's dominance over the Internet continues to grow in its first two priorities, search and advertising, and it clearly has high hopes for its third ambition, Web-based applications.

Updated at 9:17 a.m. PST: Yahoo and Google had lobbied hard to bring their partnership to fruition, trying to explain the deal to Congress, the public, and regulators. Schmidt professed confidence in the deal, saying the companies had structured it to satisfy antitrust concerns.

But the companies weren't even close, as it turned out. The Justice Department remained unmoved, saying it would file an antitrust lawsuit to block the agreement, even after a recent proposed revision that would have limited the deal's scope.

Here's how the regulators saw the deal, according to the Justice Department's statement:

"The agreement would have enabled Yahoo to replace a significant portion of its own Internet search results advertisements with search results advertisements sold by Google.

After an extensive investigation that was facilitated by the companies' cooperation and agreement to provide the department time to investigate prior to implementation, the department concluded that Google and Yahoo would have become collaborators rather than competitors for a significant portion of their search advertising businesses, materially reducing important competitive rivalry between the two companies.

Although the companies proposed various modifications to their original agreement in an effort to address the Department's antitrust concerns, the Department determined that such modifications would not eliminate the competition concerns raised by the agreement.

The Center for Digital Democracy applauded the outcome. "Today's announcement in its own way underscores what we have been telling officials: that a very tiny handful of global digital giants--particularly Google--is increasingly dominating the most prevalent way online publishing is financially supported," said Executive Director Jeff Chester. "The future diversity of online content--including news--is ultimately connected to the key question of whether one or two companies globally control the flow of most ad dollars tied to our use of broadband to PCs, mobile devices, and perhaps even digital TVs."

Yahoo, which doesn't have to pay any termination penalty, now says it's moving on.

"While the implementation of the services agreement with Google would have enabled Yahoo to accelerate its investments in its top business priorities through an infusion of additional operating cash flow, this deal was incremental to Yahoo's product roadmap and does not change Yahoo's commitment to innovation and growth in search," the company said in its statement. "Going forward, Yahoo plans to continue to provide the cutting-edge advances in products, platforms and services that the industry needs and expects, and intends to be the destination of choice for advertisers and publishers who want to reach one of the largest and most engaged populations of consumers on the Web."

Updated at 10:43 a.m. PST: Microsoft, which fought its own war with antitrust regulators, expressed predictable pleasure about the news--and the regulatory conclusion in particular.

"The Department of Justice's finding is significant for advertisers, publishers, and consumers, who voiced overwhelming concern about this illegal deal to law enforcement and policymakers," Microosoft said in a statement.

And advertisers who opposed the deal applauded the decision by the companies to step away from the agreement.

"The proposed deal was anticompetitive and would have given Google too much power over online advertising," said Larry Kilman, a spokesman for the World Association of Newspapers, which in September announced its opposition. "It's clear from the announcement that government competition authorities were receptive to the concerns raised by the advertising and media industries. We're delighted that Google and Yahoo decided to drop it."

The Association of National Advertisers, which raised its objections in September and updated its concerns this week with a letter to the Justice Department, breathed a sigh of relief.

"We knew some decision was coming soon and are grateful that the parties agreed to discontinue their agreement. It's an important step for the industry to move forward...it will stimulate the level of innovation," ANA Chief Executive Bob Liodice said.

And a proposed modification of the terms didn't satisfy him.

"When the fundamentals don't change--concerns of pricing and concentration of power--then the fact that it's a 2-year deal or a 10-year deal doesn't matter," Liodice said. "If a deal can't stand up on its own under the longer terms, then it shouldn't stand up at all under shorter terms."

Resistance from antitrust regulators has doomed Yahoo's search-ad deal with Google, The Deal has reported, but the companies emphatically say discussions are continuing.

"A proposed joint venture between rival Internet companies Google and Yahoo appears headed for the trash bin, just ahead of an expected U.S. Department of Justice challenge to the agreement, lawyers close to the deal said," according to a Silicon Alley Insider quote of the story. "The DOJ could file a complaint seeking a preliminary injunction on the agreement even as the parties assess their options. Antitrust lawyers said the government would have to clear a high hurdle to win a preliminary injunction. But it is even less likely that Google and Yahoo would want to battle the government in court over such a controversial deal, particularly while the financial market is so precarious, the lawyer said."

Yahoo and Google have twice extended their deadline to wrap up the deal, under which Yahoo would show Google's search ads in some cases and bring in $800 million in new Yahoo revenue in its first deal. But the companies said Tuesday that they're still working on making it a reality.

"We are continuing to have cooperative discussions with the Department of Justice about this arrangement and agreed to a brief delay in implementing the agreement while those discussions continue. We are confident that the arrangement is beneficial to competition, but we are not going to discuss the details of the process," Google said in a statement.

Yahoo was on the same page: "The companies agreed to a brief delay in implementing this agreement to continue our ongoing discussions with the Department of Justice. We are continuing those discussions with regulators and look forward to responding to their questions about this agreement. We believe strongly that this agreement will strengthen Yahoo's competitive position in online advertising and will help to drive a more robust, higher quality Yahoo marketplace for our advertisers, publishers, and users."

Yahoo and Google are delaying implementation of their search-ad deal to give Justice Department antitrust investigators more time to look into the deal, according to published reports.

Kara Swisher (of All Things D) and Bloomberg reported the delay Friday afternoon.

A Yahoo representative said the company is preparing a statement; Google didn't immediately respond to a request for comment.

Under the Yahoo search-ad deal with Google, which had been set to go into effect this month, Yahoo plans to display some Google search ads where its own ad-delivery technology doesn't work as well. Yahoo expects $800 million in new revenue in the first year of the deal.

Update 2:57 p.m. PDT: Yahoo and Google confirmed what they characterized as a "brief delay."

"The companies have agreed to a brief delay in implementing this agreement to continue our ongoing discussions with the Department of Justice. We have had discussions with regulators and look forward to responding to their questions about this agreement," Yahoo said in its statement.

Google added this: "When we announced our advertising agreement with Yahoo in June, we agreed to delay its implementation until October to give regulators time to look at the details. As we are still in conversation with the Department of Justice we have agreed to a brief delay in implementing the agreement while those discussions continue."

Update 4:01 p.m. PDT: Yahoo wouldn't clarify how long the brief delay would last, but the companies likely want it done before a new administration is elected one month from now and major changes could take place within the Justice Department. The Reuters news agency quoted an unnamed source who said the companies still expect to begin in October.

The companies gave themselves three and a half months to implement the deal, saying they wanted to give antitrust regulators time to review it. With the June announcement date, that would have put them in early October.

However, the companies haven't been specific about when they planned to flip the switch. In a September meeting with the press, Google Chief Executive Eric Schmidt wouldn't be pinned down beyond "roughly the beginning of October."

The partnership has come under antitrust criticism from Microsoft--whose unwelcome attempt to acquire Yahoo helped fuel the Yahoo-Google partnership--and from the Association of National Advertisers (ANA), the World Association of Newspapers (WAN) and Center for Digital Democracy. The European Union is investigating the partnership, too.

Some Democratic lawmakers from California, though, urged the DOJ not to block the deal. They criticized in particular the possibility of Justice Department legal action before the deal actually takes effect.

Facing the criticism, Google and Yahoo both have begun a publicity offensive. Google published a frequently asked questions site, and Yahoo President Sue Decker weighed in with her own defense last week. Yahoo has also published a site with partnership details to try to make its case.

Update 4:22 p.m. PDT: Several states are reviewing the deal, too, and Connecticut Attorney General Richard Blumenthal said there's been a two-week extension of the antitrust review. The deadline for review moved from October 8 to October 22, Blumenthal said.

"We are doing our review in conjunction with the DOJ, so I'd think our timetables are aligned," Blumenthal said.

Although it's notable that Yahoo and Google are giving antitrust regulators more time to review the deal, it's a step that other companies have taken in the past, as well, former DOJ antitrust attorneys said.

Deadlines can be pushed back as needed. One former attorney said companies usually are happy to give regulators more time to evaluate a transaction rather than push the issue for fear it will back the regulators into a corner and cause them to file a lawsuit to block the deal. Another source said delays are part of the natural ebb and flow of negotiations.

The top brass of the Justice Department's antitrust unit met with Google and Yahoo months ago, a departure from the more traditional path in which the DOJ staff issue a recommendation to the department's front office about whether a deal should be rejected. Traditionally, only then do the companies make their case before antitrust chieftains.

CNET News staff writer Dawn Kawamoto contributed to this report.

Yahoo and Google--put on the defensive by antitrust scrutiny and Microsoft agitating focused on the Internet companies' search-ad deal--are trying their best to reclaim the initiative as the project's launch date nears.

First came Google, with a series of blog posts and a frequently asked questions page. Now Yahoo has also joined in with a "myth-busting" blog post from Yahoo President Sue Decker.

"Here's the bottom line," Decker wrote late last week. "Yahoo will use this agreement to help us become a stronger competitor in all aspects of online advertising; and Yahoo is not exiting the sponsored search business. We plan to remain a strong player in sponsored search."

The deal, with an initial four-year term and two optional three-year renewals, is expected to give Yahoo $800 million in new revenue in its first year. It's scheduled to begin in early October, and Google Chief Executive Eric Schmidt has said the ad deal remains on its launch schedule in the absence of any opinions from antitrust regulators.

Decker offered a detailed explanation about how the search deal works and why Yahoo wants it--an explanation that probably should have been offered much earlier in the discussion.

For example, Decker goes into more depth than Google has about advertisers setting prices for keyword bids. "Where Google is getting higher bids than Yahoo today, this is because advertisers perceive that Google is delivering more value--more targeted leads, more clicks, and more conversions. That's why an advertiser might be willing to bid more for a click on Google than for a click on Yahoo--the belief that the advertiser will get more value from Google. Google is not setting prices. Advertisers determine how to value keywords.

Early on, she takes issue with a statistic thrown around by Microsoft that the deal gives Google 90 percent share of the search-ad market, a statistic that derives from combining the two companies' individual share. "That's just plain wrong," she said. "It's important to note that the agreement is non-exclusive and gives us the option to 'backfill' with Google ads if and when we see fit. The reason we structured the deal this way--rather than a more typical exclusive deal with revenue commitments to us and traffic commitments to Google--was precisely to avoid the issues the critics are raising."

It's interesting that both companies decided this relatively late stage would be the time to sway public opinion.

Perhaps in the earlier stages they didn't want to appear to be bullying the Justice Department, the European Union, and other regulators trying to assess whether the deal is anticompetitive. Or perhaps they're growing more concerned about whether the deal will emerge intact.