By Alexei Oreskovic and Bill Rigby
SAN FRANCISCO/SEATTLE (Reuters) - MICROSOFT (MSFT.NQ)Corp and Yahoo Inc inked a 10-year Web search deal to better compete against market leader Google Inc but stopped short of combining their display advertising businesses.
Yahoo shares fell 10 percent as some investors were disappointed by the limited scope of the deal, which did not include any upfront payments for Yahoo as some had expected. Shares of Microsoft edged higher, while Google shares fell 1 percent.
"Those that were looking forward to a take-out, the deal today was rather disappointing," said Marc Pado, U.S. market strategist for Cantor Fitzgerald & Co. "The 10-year pact, it's not a bad thing. It's not as good as what investors expected."
The deal culminates a lengthy, and at times contentious, dance between the two companies. They have been in on-and-off-again talks on a search partnership since Yahoo rebuffed Microsoft's $47.5 billion takeover bid last year.
Under the deal announced on Wednesday, Microsoft's Bing search engine will power search queries on Yahoo's sites. Yahoo's sales force will be responsible for selling premium advertising based on search terms for both companies.
Microsoft's AdCenter technology will serve the standard sponsored links that appear alongside search results.
While Yahoo CEO Carol Bartz had previously said that any deal would require a partner with "boatloads of money," she said on Wednesday that the revenue share agreement in the Microsoft deal was more valuable to Yahoo than a one-time payment.
"Having a big up-front cash payment doesn't really help us from an operating standpoint," Bartz said in a conference call with Microsoft CEO Steve Ballmer.
Microsoft will compensate Yahoo through a revenue-sharing agreement that pays Yahoo at an initial rate of 88 percent of search revenue generated on Yahoo sites in the first five years.
Each company will maintain its own separate display advertising business and sales force, they said.
Analysts said it will be tough for the two companies to make a significant dent in Google's dominance in search, but it was a step in the right direction.
According to comScore, Google has a 65 percent share of the U.S. search market, compared to Yahoo's 19.6 percent and Microsoft's 8.4 percent.
"Overall, it's a big positive for two companies that have been struggling to keep up with Google. This consolidates their resources and allows them to make a more concerted push as the No. 2 entity," said RBC Capital Markets analyst Ross Sandler.
Yahoo estimated the deal will boost its annual operating income by about $500 million and yield capital expenditure savings of $200 million. Yahoo also expects the deal to boost annual operating cash flow by about $275 million.
Yahoo reported income from operations of $13 million in 2008, hurt by $487.5 million in goodwill impairment charge and $107 million in restructuring charges. In 2007, operating income was $695 million.
Yahoo's Bartz said that the deal will result in "redundancies" in Yahoo's staff, though she declined to be specific. And she stressed that any changes would not occur until after the deal is approved by antitrust authorities in the U.S. and Europe.
The companies said they expect the deal to be "closely reviewed" by regulators, but were "hopeful" it can close in early 2010.
Shares of Yahoo were down $1.92 at $15.30 in early Nasdaq trading. Shares of Microsoft were flat at $23.47. Google shares fell $6.77 to $433.07.
(Additional reporting by Tiffany Wu, Paul Thomasch, Robert MacMillan and Diane Bartz; Editing by Derek Caney)
