Microsoft, Yahoo deal was a long time in the making

Possibility of search deal first came up last year

It's been a long road to the search deal between Microsoft Corp. and Yahoo Inc. that was finally announced today. The possibility that Yahoo might be open to a deal involving its search ad business emerged while Microsoft was in the midst of trying to acquire the company last year.

After Microsoft's original Feb. 1, 2008, offer of $31 per share, or about $44.6 billion, rumors began to circulate about discussions between Yahoo and Google on a search ad deal, although neither company initially confirmed the talks. But in April last year, Yahoo acknowledged that it would begin a "limited test" of Google's AdSense for Search service to run Google ads in Yahoo's U.S. search engine.

When Microsoft dropped its acquisition offer in early May 2008, it cited as one of the main reasons for walking away the possibility that Yahoo could enter into a search ad deal with Google.

Having given up on acquiring all of Yahoo, Microsoft nonetheless attempted to acquire Yahoo's search business at least twice afterward. In June 2008, it offered to pay $1 billion for the search assets and to invest another $8 billion in Yahoo at $35 per share.

The offer called for Microsoft to assume the search operations and R&D expense while returning data back to Yahoo for use in its other, non-search advertising business. The partnership included a three-year guarantee by Microsoft of better financial results than Yahoo's search ad system provided.

Such a combination, Microsoft argued, would offer strong competition to Google, whose stranglehold on the highly lucrative search ad market has been Microsoft's primary motivation in pursuing Yahoo.

Yahoo begged to differ and rejected Microsoft's offer on June 12, 2008, saying that selling its search ad business to Microsoft clashed with Yahoo's belief that it needs to own both a search and display ad business, because they are converging.

Later that same day, Yahoo and Google announced a nonexclusive deal for Yahoo to run ads provided by Google on Yahoo's search engine and on some of its Web sites. The deal gave Yahoo control over which search queries would trigger Google ads and over where those ads would appear.

The deal, limited to search inventory in the U.S. and Canada, represented an opportunity for about $800 million in revenue, Yahoo said. At the end of its first full year of implementation, the deal would generate between $250 million and $450 million in incremental operating cash flow for Yahoo.

The deal also included a disincentive for shareholders to oust the Yahoo board and replace it with new members, which billionaire investor Carl Icahn had been agitating for at the time.

If such a "change in control" happened within 24 months of signing the deal, Google could terminate the agreement unilaterally and force Yahoo to pay a "termination fee" of as much as $250 million.

Microsoft lost little time leading a chorus of critics objecting to the deal on the grounds that it would hurt competition, drive up prices and reduce options.

Yahoo and Google dismissed the criticism, but they also proactively agreed to hold off on implementing the deal to give the U.S. Department of Justice a chance to review it.

In the meantime, in July of last year, Microsoft presented another offer for Yahoo's search business, this time in conjunction with Icahn, who by then had acquired an almost 5% stake in Yahoo and was loudly complaining about CEO Jerry Yang and the Yahoo board.

Yahoo also rejected this sweetened offer, saying that its deal with Google was better because it didn't require Yahoo to sell its search ad business.

Yahoo also complained that Microsoft and Icahn made a "take it or leave it" offer and gave it less than 24 hours to make a decision.

In addition, the offer required the immediate replacement of Yahoo's board and the removal of the company's top management, Yahoo said.

Microsoft countered by saying that it had made the enhanced offer at the request of Yahoo board Chairman Roy Bostock, and that the proposal didn't require changes to Yahoo's board or top management.

The new deal offered "significant revenue guarantees, higher [traffic acquisition cost] rates, an equity investment and an option for Yahoo to extend the agreement over a 10-year period," Microsoft said.

Microsoft also took issue with Yahoo's description of the offer as "take it or leave it." Microsoft had asked Yahoo to inform the company if Yahoo considered the enhancements to the deal sufficient in order to proceed to more formal and detailed negotiations.

Unfortunately for Yang, in early November, Google pulled out of the search ad deal signed in June after it became apparent that the DOJ was going to challenge it in court over antitrust concerns.

A couple of weeks later, Yang announced he would step down as CEO as soon as a replacement is found, while staying with the company as Chief Yahoo -- his former title -- and board member.

In early December, Ballmer indicated that Microsoft was interested in doing a search ad deal with Yahoo "sooner rather than later."

In January, Yahoo hired former Autodesk CEO Carol Bartz as CEO to replace Yang, and announced that President Sue Decker, a staunch Yang supporter who had been a candidate for the CEO position and had worked at Yahoo for almost nine years, had resigned and would leave after a transition period.

From the beginning of her tenure, Bartz has fielded questions regarding a possible search ad deal with Microsoft, and said that she was not closed to the idea, but that the terms and price must be right.

Yahoo and Microsoft have reportedly held talks about a possible search ad deal since Bartz took over, various media outlets have reported, quoting anonymous sources.

In late May, during an onstage interview at the All Things D conference in Carlsbad, Calif., Bartz said she was open to discussing a Microsoft acquisition, provided the deal was sweet.

"If there's boatloads of money and the right technology involved, we'd do a deal, sure," she was quoted as saying in the Wall Street Journal. "It's that simple."

Copyright © 2009 IDG Communications, Inc.

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