Microsoft and Yahoo Announce 10-Year Search Deal

And so the deal is finally done: Microsoft and Yahoo early this morning announced a 10-year deal that provides a united front against search giant Google. As we wrote last night, the deal essentially turns over Yahoo's search service to Microsoft and its newly launched Bing search engine, while Yahoo will be responsible for all search ad sales, using Microsoft's ad sales technology.

Although Yahoo estimates the deal will mean $500 million a year in operating income, $200 million in savings on capital spending, and $275 million in extra operating cash flow, investors don't appear too happy. The stock is down nearly 10% in early trading. They may be reacting to the lack of a large upfront payment that was rumored in earlier talks, as well as the uncertainty about how well the complex deal will be executed.

Most analysts seem to think Microsoft got the best of the deal, paying relatively little money (compared with its huge reserves and cash flow) essentially for control of the No. 2 position in search vs. Google. While Yahoo gets a fair amount of cash, it no longer will have fundamental search technology, arguably still the key technology of the Internet age. For what it's worth, Jason Calacanis of the people-powered search firm Mahalo, thinks Yahoo just committed suicide. Larry Dignan at ZDNet's Between the Lines blog also draws disturbing parallels between Yahoo and AOL.

But if Yahoo can actually execute on its promise to focus its resources on rejuvenating its brand, user experience and most of all display, video, and emerging forms of nonsearch advertising, it may also win ultimately. That's the counterpoint view of venture capitalist Bill Gurley, who questions how it makes sense to pursue a runaway leader like Google on its own turf.

In any case, both Microsoft and Yahoo have a lot of work to do for the deal to work for either. The deal will take until at least early next year to close, and that's assuming everything goes smoothly and antitrust officials don't take too long approving it.

A smooth transition is far from certain. Yahoo CEO Carol Bartz and Microsoft CEO Steve Ballmer said on a conference call this morning that the term sheet for the deal is well over 100 pages long. "That's why we had to make sure we had a partnership" as opposed to a one-off deal, Bartz said, conceding the "distraction" of integrating the companies' search operations. As Henry Blodget at Silicon Alley Insider notes, splitting technology and sales creates inevitable conflicts.

Bartz also said a large upfront payment with lower revenue sharing wasn't as interesting to Yahoo because "we're trying to run a long-term business. This a true partnership. Frankly, both of us have skin in the game." Yahoo "needed to get focused," she added, and this helps it achieve her stated goal of being the center of people's lives online. What's unsaid is whether Yahoo simply couldn't negotiate a large upfront payment. But at the same time, retaining search ad sales, even on Microsoft's technology platform, does give Yahoo more control over the breadth of ad sales on its sites.