When Google tried to boost Yahoo’s search business last year with a
revenue sharing deal, regulators and advertisers cried foul. But that
deal had the potential to do something that this one will not: help
Yahoo prop up its flailing search business.

Today Yahoo and Microsoft announced a search merger that will cede Yahoo’s marketshare to Microsoft, making the software giant the defacto runner up to Google in the search category. But what will it mean for Yahoo? The Sunnyvale-based company will get a large chunk of their combined search revenues for the next few years, but for many it looks like this deal is the death knell for Yahoo search.

Yahoo’s stock fell 12% on the announcement, the biggest drop since
November, to close at $15.14 today. Meanwhile, Microsoft stock rose 33 cents to
$23.80. And to many, this deal was negotiated in Microsoft’s favor.

“While the details of the deal
can confuse the risks and benefits to Yahoo!, this deal ultimately
means that Yahoo! is outsourcing search to Microsoft,” Needham & Company analyst Mark May told AllThingsD. “If you’re bullish on search, and on the power of having
combined strength in both search and display, I think you’d have to
view this deal as negative for Yahoo! and positive for Microsoft.”

It looks increasingly like Yahoo, once the leader in online search, is throwing in its search chips. Last year, Microsoft was looking to purchase Yahoo outright, but this deal comes with no cash upfront. Instead, Yahoo has negotiated a percentage of shared search earnings over the next few years. In the first two years of the deal, Yahoo will collect 110% of all search revenue. In the third, Yahoo will get 90%.

The company went into the deal “to keep a healthy revenue stream,” according to Bartz. And the revenues coming in from the search business will help the company invest in areas “critical
to our future,” such as display advertising, mobile experiences, and
audience properties.

But after stalled deals with both Microsoft and Google in the past year, Yahoo has been hurting. And it shows. Benchmark Co.’s Clayton Moran told Bloomberg: “This deal was a big disappointment. [Yahoo] needed this deal, and it shows in terms of how the negotiations were concluded.”

Now, Yahoo will allow Microsoft technology to power its search queries and will cease development of its own search engine.

Analysts were down on the deal today. “It goes without saying that the terms of the Microsoft/Yahoo search
deal were below Street expectations,” Cowen and Co. analysts told the Wall Street Journal today. And Thomas Weisel Partners Yahoo analyst Christa Quarles said since the
deal appears to be less valuable than earlier offers, it “leads to the
question of, ‘Does Yahoo now think its [search] asset is a
deteriorating one?’”

But entrepreneur Jason Calacanis was the most bearish on the prospects for Yahoo’s search business, saying that “Yahoo committed seppuku today” on his blog:

“The once proud warrior of the internet space laid down its sword, knelt at the feet of Microsoft and gutted itself today. There was no honor in this death, it was one brought by the shame of losing to Google and a lack of faith in one’s ability to compete in the space they created.”

The deal gives Yahoo a few years of search revenue to jumpstart its other businesses, but it’s not clear that it will be able to turn around its approach to the soft display market by then. Bartz estimates that the deal will give Yahoo about $275 million in annual operating cash flow to focus on other aspects of its business, but the company has been working towards that goal for years and hasn’t managed to find a silver bullet business strategy yet.

For the company that was once the dominant player in search, that is a
sad fact. Writes Danny Sullivan:

“There
was a time when the mighty Yahoo roared above all other search engines.
When people were so worried about being listed in Yahoo that they
pondered lawsuits over the issue, because not being in Yahoo was like
not being on the internet at all.”

Wittling the search market down to two major players is sure to face considerable regulatory scrutiny. But if the deal passes through Congress, the companies estimate that it will take two years to fully implement. Microsoft will have inflated its status on search, bumping up to the number 2 player in the space.

Will Yahoo and Microsoft’s announcement help them topple Google?
Unlikely. Will it help Microsoft wring some extra dollars from search?
Yes. Will Yahoo’s search business survive? Well, it looks like Yahoo has given up the ghost on that one.