Microsoft-Yahoo! Deal Finalized

On Thursday, the long-discussed Microsoft (MSFT: 28.77 -0.199 -0.69%)-Yahoo (YHOO: 15.58 +0.04 +0.26%) deal was finally cleared by both European and U.S. regulators.
 
Microsoft shares jumped 1.33% in response to the news, but lost 1.1% after-hours. Yahoo shareholders appear to be viewing the news negatively, with shares rising just 0.65% during the day and losing 1.22% after-hours. Google Inc. (GOOG: 540.763 -2.457 -0.45%) shares also followed the same pattern, but registered a net increase. The Nasdaq was up 0.69% yesterday and the S&P 500, up 0.66%.
 
The U.S. search market is dominated by Google, which had a 65.4% market share in January 2010, with Yahoo! a distant second at 17.0% and Microsoft third at 11.3% (comScore estimates). According to StatCounter, Google’s global market share at the end of 2009 was 90%. Google has gained significantly in China too, with a 2009-end market share of 43%, compared to Yahoo and Microsoft’s combined share of 1.18%.

The growth in China is very significant in the global context, since it is one of the fastest-growing international search markets. Google’s gains in the country have come largely at the expense of local company, Baidu, Inc. (BIDU: 500.15 +2.546 +0.51%).
 
Given the above statistics, the approval was not surprising, since Yahoo! and Microsoft’s combined share is well below Google’s, so a combination could only increase competition and not reduce it.
 
Moreover, the clearance by Australian and Canadian authorities in November last year further strengthened our view that the deal would go through.
 
The ten-year agreement, first proposed in July last year, allows Microsoft to power, control and process search-related information. Yahoo gets to collect advertisements and keep 88% of the revenue.
 
Microsoft will now be in a position to collect user information in larger volumes, through which it can more correctly determine user preferences and thus attract more users. This in turn will attract more advertisers and thereby generate more revenue.
 
Yahoo! will save around $200 million in search expenses and increase $500 million in search advertising revenue once the deal closes. While the terms are subject to revision a few years down the line, it is obvious that the company has created a cash cow.
 
For the next ten years, Yahoo will be able to build strategy and focus resources on other areas, including banner advertisements on its portal and email pages. It will also be in a position to strengthen relationships with advertisers, the source of all revenue and profits.
 
We currently have a Neutral recommendation on both Yahoo! and Google, but are more optimistic about Microsoft.