Yahoo, jilted by Google, may yet find comfort in Microsoft's arms

By Jim Puzzanghera and Jessica Guynn

Nov. 6, 2008 12 AM PT

Puzzanghera and Guynn are Times staff writers.

SAN FRANCISCO, AND WASHINGTON — Google Inc. tossed floundering Internet rival Yahoo Inc. a life preserver four months ago when the two companies agreed to a search advertising deal. But with federal regulators ready to challenge the plan on antitrust grounds, Google abruptly cut the rope Wednesday, setting Yahoo adrift again.

And, just as earlier this year, there’s a familiar shark circling Yahoo in the water: Microsoft Corp.

Yahoo has shrinking options for a rescue that would help the 15-year-old company remain independent, and Chief Executive Jerry Yang’s job is in trouble, analysts say. But Yahoo’s stock rose as much as 11% Wednesday on speculation that Microsoft would make another bid for its search business. Shares closed up 57 cents, or 4%, at $13.92.

“The loss of the Google deal is going to cause cascading problems for Yahoo,” said Sanford C. Bernstein analyst Jeffrey Lindsay. “It’s hard to see how Jerry Yang survives it.”

The Sunnyvale, Calif., company’s hopes of boosting its annual revenue by $800 million through the Google partnership were torpedoed by the objections of Justice Department antitrust officials, who asserted that the deal would erode competition in the online advertising market.

“The arrangement likely would have denied consumers the benefits of competition: lower prices, better service and greater innovation,” said Thomas O. Barnett, who oversees the department’s antitrust division.

Speaking at the Web 2.0 Summit, a conference for Internet executives, in San Francisco on Wednesday night, Yang said he was disappointed in government regulators for not understanding the online advertising business, and in Google.

“It was disappointing to us that they didn’t want to defend this deal,” he said of the search giant.

Google had much less at stake in the deal than Yahoo. With one goal already accomplished -- staving off a Microsoft acquisition of Yahoo -- Google executives canceled the deal after the Justice Department told them it was headed to court to block it.

But Google, based in Mountain View, Calif., may not have emerged unscathed. The antitrust review and opposition to the Yahoo deal, stirred up by Microsoft, have led to a deep awareness -- and growing concern -- by regulators of Google’s online dominance.

Rebecca Arbogast, an analyst with brokerage Stifel, Nicolaus & Co., said that scrutiny is not welcome, “just like one never wants to have an IRS audit, even if you haven’t done anything wrong.”

Google said it believed the agreement would have been good for Internet users, advertisers and publishers.

“However, after four months of review . . . it’s clear that government regulators and some advertisers continue to have concerns about the agreement,” said David Drummond, Google’s chief legal officer and senior vice president for corporate development. “Pressing ahead risked not only a protracted legal battle but also damage to relationships with valued partners.”

The deal was announced June 12, the same day Yahoo and Microsoft ended months of unsuccessful talks on a merger or partnership, including an unsolicited $31-a-share offer from the software giant in February. Google agreed to broker some text ads for Yahoo’s search engine, which Yahoo hoped would appease investors by boosting its profitability.

The companies agreed to delay implementation of the agreement to deal with the antitrust concerns raised by a partnership between the two top search engines.

The Justice Department said its review determined that Google and Yahoo would “become collaborators rather than competitors for a significant portion of their search advertising business.” Over the last two months, Google and Yahoo offered to narrow the deal’s length and scope to address the concerns. But the Justice Department decided those changes weren’t enough.

“Everyone recognized that Yahoo was committing itself to a very costly addiction in return for this flood of Google dollars,” said Jeffrey Chester, executive director of the Center for Digital Democracy, one of several groups that opposed the deal, including the Assn. of National Advertisers and the World Assn. of Newspapers. “It would have become hooked and dependent on what is supposed to be its key competitor.”

Microsoft cheered the demise of what it called an “illegal deal,” but the Redmond, Wash., software giant would not comment on its interest in Yahoo. Chief Executive Steve Ballmer said last month that a search-related deal could make economic sense for both companies and there could be “continuing opportunities” for a partnership. But Microsoft said the same day that it had “no interest in acquiring Yahoo.”

Yang said Wednesday that Yahoo would be “very open-minded” about a search partnership with Microsoft, but that he believed the best thing Microsoft could do would be to buy Yahoo “at the right price,” though he didn’t specify what that was. The two companies couldn’t reach an agreement on price earlier.

“Did we want to do the deal with Microsoft to sell the company? Yes,” he said. “Had we been able to do so, we would have been very happy. It was not meant to be.”

Analysts said Yahoo was in deep trouble now that Google had severed its lifeline.

Yang is under pressure to revive his company’s financial growth and boost its moribund stock, which has lost more than half its value since the co-founder took over as CEO in June 2007. He has also pursued a possible acquisition of AOL with its corporate parent, Time Warner Inc., for nine months. But those discussions, which would swap AOL for a percentage of Yahoo, have not progressed as both sides haggle over AOL’s worth.

Without the extra revenue from Google, Yahoo probably couldn’t meet AOL’s asking price anyway, Lindsay said.

Meanwhile, Yahoo shareholders, along with new board member Carl Icahn, are pushing for renewed talks with Microsoft. And pressure may mount for management change.

“At some point, the board needs to step in because Yahoo is still a valuable asset,” said Anthony Valencia, a media analyst for TCW Group in Los Angeles. “They need to do something prior to reaching a point when it is not a leading Internet asset.”

Said Yang, “My job is to figure out how to find the right path for Yahoo. I don’t know what else we could have done.”

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