Microsoft Offered $9 Bln for Yahoo Stake, Search Deal

SEATTLE/SANFRANCISCO (Reuters) – When Yahoo Inc turned down the latest offer fromMicrosoft Corp this week, it walked away from $9 billion in cash and $1billion a year in additional operating profit, Microsoft said on Friday.

In an e-mail to employees, Microsoft platforms and services divisionpresident Kevin Johnson said it had offered $8 billion for a 16 percentstake in Yahoo and $1 billion to buy Yahoo’s search business and assumeits operations.

The proposal also included a revenue-sharing partnership that wouldhave delivered $1 billion a year in additional operating income toYahoo due in part to a three-year guarantee of better rates foradvertisements tied to its search results than Yahoo’s current Panamaadvertising system.

Microsoft’s most recent offer was an alternative to its previousfull acquisition proposal. Instead, Yahoo entered an advertisingagreement with Google Inc on Thursday.

Microsoft, a dominant force in desktop software but a laggard inonline search advertising, is still open to discussing its alternativeproposal despite Yahoo’s partnership with Google, a source familiarwith Microsoft’s thinking said.

Yahoo had no comment. Microsoft spokesman Jeff O’Mara declined to comment.

Another source familiar with the matter said Microsoft had proposeda 10-year exclusive deal to handle Yahoo’s search advertising and onlyguaranteed higher advertising rates for three of those years. Johnson’se-mail did not mention the duration of the deal, only saying it was"long term."

By contrast, Yahoo’s deal with Google, which will pit the twocompanies’ ads against each other in an auction, is non-exclusive. Itmeans other companies can join in the auction to bid to place ads nextto Yahoo’s search results.

"Unfortunately Yahoo has chosen a different course, and yesterdayannounced an agreement that would start to consolidate over 90% of thepaid search advertising market in Google’s hands," said Johnson in thee-mail.

"This will make the market far less competitive."

The deal with Google would boost Yahoo’s cash flow by $250 millionto $450 million in the first 12 months, according to Yahoo. It would beless than half of Microsoft’s forecast for $1 billion in additionaloperating income, the source familiar with Microsoft’s thinking said.

A BETTER DEAL?

Microsoft said its proposal would have delivered $1 billion ofincremental operating income to Yahoo because it would reduce Yahoo’soperating costs for running search and the company would receive largepayments in the form of so-called traffic acquisition costs (TAC) fromMicrosoft.

Yahoo would also not have to make hefty research and development investments for search, Microsoft said.

"On the surface, it looks like a better deal," Gartner analyst DavidMitchell Smith said of Microsoft’s search deal proposal for Yahoo.

Smith cautioned, however, that there may have been issues not revealed publicly that made the Google deal a better option.

Microsoft abandoned its offer to buy all of Yahoo in May asnegotiations dragged on, making it unlikely that a deal could completeregulatory review during the Bush administration, the source said.

If the full acquisition could not get approval by year-end, thereview process could have carried on until as late as October 2009,meaning that Microsoft would have to carry the capital risk of a$40-billion-plus acquisition for 18 months.

It also became less interested in a full acquisition after Yahoo’ssearch share continued to deteriorate more than Microsoft had forecast,the source said. A lucrative severance agreement put in place byYahoo’s management also made a full acquisition less appealing, thesource said.

Microsoft structured its alternate proposal to focus solely onsearch to take into account Yahoo’s concerns that combining the twocompanies’ e-mail and instant messaging users would not gain regulatoryapproval, the source said.

Shares of Microsoft closed up 83 cents, or 2.94 percent, at $29.07on the Nasdaq, while Yahoo closed down 5 cents, or 0.21 percent, at$23.47.

(Additional reporting by Michele Gershberg in New York, Editing by Gerald E. McCormick, Carol Bishopric, Gary Hill)