Microsoft Yahoo Deal: Why it is a good deal for Microsoft and Yahoo?

What a difference a year makes. Last year, Microsoft offered $40+ Billion to get access to Yahoo!’s search traffic but yesterday, Microsoft announced a deal where it got Yahoo’s traffic almost at no premium. Of course, if I were Yahoo shareholder I would be very unhappy about Yang’s decision of not accepting the offer last year.

Why it is important for Microsoft? Search is a business of scale, more people search, your product and algorithm gets better. More searchers will attract more advertisers and generates higher revenue from advertisers. With this deal, instantaneously, Microsoft can scale three times its current size, can fast forward its product development and receive higher price for its ad inventory.

Analyst estimates put Microsoft’s search division to make $600-$700M and prices for ads in Bing.com is almost half (1/2 ~ 1/3) the price of Google’s. With this deal, if Microsoft catches with Google in terms of ad pricing, revenue for Bing will double with no additional cost. A value of ~$500- 600M per year for shareholders. $500M * multiple of 10 = $5Billion in value.

With help of the deal, if the product improves and Bing.com brand presence improves, and Bing.com captures another 4% share to grow from current 8% to 12% market share, revenue will double with disproportionately small incremental increase in investment, creating another $500-$600M (at a higher monetization from the deal) in revenue. Potentially, another $5B in value for Microsoft.

What does Yahoo get? Yahoo clearly understands if it wants to be in Search it has to fight with two 500 pound gorillas – Google and Microsoft. These two giants have almost endless source of cash to invest. Yahoo can either compete and invest tons of money in Search or it save its investment and can concentrate on its other products Yahoo portal, yahoo mail etc.

From yahoo’s point of view, Search is getting commoditized and why to invest and still fall behind? hence outsource the search to a specialist. According to Yahoo CEO the deal could “add $500 million annually to Yahoo’s operating income” and will ease Yahoo’s Capex. Over $5-7B in value for Yahoo from these savings.

Why wait till launch of Bing.com? it was clearly a bet from both sides. Microsoft kept its bet that Bing.com will be a hit. On the other hand, Yahoo was hoping that Bing.com will fall flat. In reality, Bing.com did well and helped Microsoft share to increase to 8.4%. This gave Microsoft an upper hand. If Bing.com continues to gain share, Yahoo will continue to lose its negotiating power. Hence Yahoo had to close the deal as soon as possible. If Bing.com would have been flop and have received bad reviews, the story would have been different.

Overall, Microsoft shareholders are the winners who got something for free when they were ready to pay $44B for it a year before.

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