Yahoo makes Google ad deal, Microsoft talks fail

Microsoft's plan to establish a strong footing in online advertising suffered a big blow on Thursday as merger talks with Yahoo finally, formally failed and Yahoo said it would let Google sell search ads on its site.

Separate statements from Microsoft and Yahoo signalled a real rift between the two after their agonising on-again, off-again talks, and Yahoo shares fell 10 per cent as final hopes of a full or partial acquisition faded.

Microsoft shares rose more than four per cent as investors showed relief that the company would not be paying too high a price for a deal they considered risky - even though its biggest rivals on the Web aimed to work together.

Yahoo said it had agreed to let Google put search ads - advertisements placed next to search results - on its site in what it called an €518 million annual revenue opportunity that would boost cash flow by €162 million to €291 million in the first 12 months.

"Google has made an enormous gain strategically. This move might well have shut Microsoft out of the online space altogether," said Sanford Bernstein analyst Jeffrey Lindsay.

Google and Yahoo, No. 1 and No. 2 in search, will pit ads against each other in auctions for the ad that pays the most.

"Yahoo is being a reseller of Google whenever it makes sense, and that is likely to be a lot of the time, given how much more effective Google Web search ads have proven to be," Global Crown Capital analyst Martin Pyykkonen said.

The process is non-exclusive, meaning others could join in the bidding to place ads, a factor that could make a deal easier to pass regulatory approval. The companies agreed to wait three-and-a-half months for regulatory approval and to offer a way to end it if Yahoo is taken over.

But the prospect of combining the top search ad vendors in one system immediately raised fears.

Google chief executive officer Eric Schmidt likened the deal to ones in other industries where rivals find ways to cooperate even as they compete.

"The decision of showing ads is a Yahoo decision, not a Google decision," he said. Yahoo rejected Microsoft's latest proposal, which sources briefed on the subject said included an offer to buy 16 percent of Yahoo for €22.6 per share, plus to buy its search business.

Yahoo simply said that an alternative Microsoft proposal to buy only its search business did not fit into its plan to grow search and display advertising. Microsoft's offer for a minority stake was at a premium per share to its early May offer to buy the entire company for €30.4 billion, or €21.3 per share.

Microsoft, which said it was still open to an alternative deal, had hoped a Yahoo deal would accelerate its ability to capitalise on Web advertising growth and compete with Google, which is increasingly fighting for the same internet audience.

Yahoo said Microsoft had made it clear in a meeting last Sunday that it was no longer interested in buying the company outright, even at the €21.3 per share price Microsoft had most recently proposed.