On Saturday, Microsoft formally withdrew its offer to acquire the search pioneer, at least for now. So what happens next for Yahoo? A deal with Google looks likely.
The search company had planned to announce the partnership by midweek, a source familiar with the plan said. Under the deal, Google would supply text ads next to Yahoo search results; Yahoo conducted a limited-scope test of the Google ads for two weeks in April.
How exactly the potential partnership could come to fruition remains unclear with Microsoft walking away from its Yahoo acquisition offer.
On the one hand, Microsoft's withdrawal reduces some urgency and gives Yahoo more flexibility to chart its own course. On the other hand, Microsoft's attempt to acquire Yahoo has raised shareholder expectations for where the search pioneer's stock price should be.
Citigroup analyst Mark Mahaney and colleagues estimated in a February report that Yahoo makes less than 4 cents per click on its search ads to more than 9 cents for Google, so sharing could help Yahoo generate more cash and help Google deliver more ads.
Pairing the number one and number two search-ad companies could raise antitrust issues, but Yahoo had planned to address the situation by offering an open system in which others besides just Google could offer ads, the source said. It would employ a dynamic bidding system that would place the ad that would generate the highest revenue. It's unclear whether Yahoo has extended any offers to others, such as Microsoft, to participate.
Yahoo declined to comment on the planned announcement.
But relying on Google for ads, even in a limited way, is in effect admitting defeat in a key part of Yahoo's business. Even if it gets more money from the higher revenue per click generated by Google's ad technology, relying on its biggest adversary raises the possibility that a central part of the company's business could be hollowed out.
Microsoft CEO Steve Ballmer has already given his verdict on a Google union.
"We regard with particular concern your apparent planning to respond to a 'hostile' bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo today," Ballmer wrote in a message to Yahoo CEO Jerry Yang announcing the offer had been withdrawn. "In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo undesirable to us."
Can Yahoo turn ads around?
Of course, with Microsoft walking away from Yahoo, Yahoo could walk away from Google. For that strategy to be successful in the long run, Yahoo would have to reverse the steady market share losses to Google in search ads and to strengthen its display-ad business.
And it's not a great market for a turnaround. Yahoo will have to prove its advertising merits during an economic slowdown that so far has left Google unfazed.
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All these options, though, must be assessed in light of the company's stock performance on Monday. Without Microsoft offering a convenient assessment of Yahoo's worth, shareholders will have to reassess Yahoo's ability to build its stock up to that level on its own.
A serious decline in value is in effect a major vote of no confidence that could help restart a new Microsoft offer. Chief executive Jerry Yang, already under pressure, would face even more.
One source familiar with Yahoo's negotiations sees Microsoft's move as an indication that it'll be business as usual again for the companies.
"I'm not surprised" by Microsoft's withdrawal, the source said, declining to speculate about whether it might return later with another offer. "They had their price and we had ours, and now people will just go about their business."
Even if the Microsoft offer really is dead, it seems unlikely Yahoo can turn the clock back to 31 January and hope we'll all forget about that pesky Microsoft distraction. Shareholders, for one, got a taste of Yahoo stock at a much higher level than the search company had been able to reach on its own.
Through its ad partnership test with Google, Yahoo has shown it's willing to take drastic measures to turn its business around. Even without Microsoft around to pump up the stock price, the company has raised expectations for better performance.
CNET News.com's Dawn Kawamoto contributed to this report.
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