Yahoo, AOL close in on tie-up deal

Updated: 2008-04-10 09:54

Some major Yahoo shareholders, including Legg Mason Inc. portfolio manager Bill Miller, have subsequently said they likely wouldn't support Microsoft in any hostile contest were it to lower its bid. At the same time, they're skeptical that Yahoo could come up with an alternative, such as a combination with AOL, that would be more palatable to shareholders than Microsoft's offer.

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Yahoo's sites had the most US visitors in February, with 137 million, while AOL's 109 million visitors put it fourth behind Google and Microsoft, according to research firm comScore Inc.

Yahoo said its test with Google will last up to two weeks and involve no more than 3% of Yahoo's Web search queries. It is designed for Google and Yahoo to evaluate the revenue potential of a broader search-ad sales outsourcing arrangement, according to people familiar with the matter. Yahoo views the latest test partly as a way to demonstrate its belief that it is worth more than Microsoft has offered, one of the people said.

"Yahoo will be testing Google's AdSense for Search service, which will deliver relevant ads alongside Yahoo's own natural search results," said Google in a statement. "This is only a limited test and does not necessarily mean that Yahoo will join the AdSense program."

Analysts have predicted outsourcing its search ads to Google would boost Yahoo's cash flow, since Google's system generates significantly more revenue for each search query than Yahoo does. Under such an arrangement, Yahoo would likely garner a majority of the revenue and Google would keep the rest as a commission.

But antitrust experts say any broader ad pact between the two would likely face intense regulatory scrutiny, given the companies' significant shares of the Web-search and online-advertising markets.

"Any definitive agreement between Yahoo and Google would consolidate over 90% of the search advertising market in Google's hands," said Microsoft in a statement. "This would make the market far less competitive."

Microsoft's statement added, "Our proposal remains the only alternative put forward that offers Yahoo shareholders full and fair value for their shares."

Citigroup Global Markets analyst Mark Mahaney, in a February research note, estimated that Yahoo could boost its cash flow more than 25% annually by outsourcing all its search advertising to Google. Yahoo executives considered such a maneuver as part of a strategic review last year, according to people familiar with the matter, but Yahoo Chief Executive Jerry Yang in October signaled that they had decided against it.

"We believe having a principal position in both search and display advertising is critical to creating...long-term shareholder value," Mr. Yang told analysts during Yahoo's earnings conference call in October.

Several factors may have spurred a change of heart toward Google, including the Microsoft offer and a 2008 revenue outlook considered tepid by many investors.

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