LookSmart shares drop on MSN news

Shares of LookSmart plummeted by more than 50 percent Tuesday, a day after the search-directory company announced the loss of its biggest customer, Microsoft.

Stock in the San Francisco-based company fell to $1.42 in early afternoon trading on the Nasdaq, down nearly 53 percent from its opening-day price of $3.02. The precipitous decline was prompted by LookSmart's announcement after market close Monday that it would not renew its distribution agreement with Microsoft's MSN. Microsoft is building its own Web search tool that is expected to replace those from third-party providers.

The announcement severely weakened LookSmart's position in the paid-search market, in which the company sells advertisers exposure in directory results that appear on partner sites, including MSN. LookSmart collects fees from advertisers each time Web surfers click on their listings; and the company splits that revenue with partners. MSN accounted for 65 percent of that revenue in the second quarter.

US Bancorp Piper Jaffray senior research analyst Safa Rashtchy downgraded LookSmart's shares on Tuesday morning, citing the company's weak future prospects.

"This loss is not only serious because of the massive revenue impact, but we believe it could make it more difficult for LookSmart to get new partners," Rashtchy wrote in a research note.

LookSmart did not immediately respond to requests for comment.

Rashtchy said he thought the deal was lost not because Microsoft saw LookSmart as a competitor of future in-house products or as something that wasn't valuable. Rather, MSN likely decided to cut the service because directory listings, of the type made common by Yahoo, have largely been superseded by Google-style algorithmic search. He lowered his 2004 earnings expectations for LookSmart to $67.8 million from $194 million.

On the positive side, Rashtchy said LookSmart could be an interesting takeover candidate for other search companies. LookSmart will likely retrench by focusing on licensing directory results to small and midlevel Internet operators, utilizing its 30,000 advertisers and $60 million in cash, Rashtchy said.

LookSmart may also see some revenue in 2004 from MSN indirectly through its partnership with Inktomi, he said. LookSmart provides "backfill" directory results to Inktomi, which MSN will likely continue to use next year. Backfill listings are complementary results that often appear on the second or third page of listings and serve to round them out.

LookSmart's turn in fortune comes as Microsoft homes in on Web search, both for its potential revenue and for the possibility of future tie-ins with the Windows operating system. In July, Microsoft quietly launched a software program called MSNBot, which scours the Web to collect links and organizes them into a search directory.

Executives at the Redmond, Wash.-based company have indicated a desire to create their own search engine to compete with industry leader Google. More importantly, Microsoft is hoping to get its search technology into the next version of its Windows operating system, called "Longhorn."

A Microsoft representative was not immediately available for comment.

CNET News.com's Jim Hu contributed to this report.