It's True: Yahoo Will Test Outsourcing Search Ads to Google

By the time you read this, Yahoo will have announced that it is launching a test to run Google ads alongside a limited number of Yahoo search results. I’ve confirmed with two people close to the matter that the deal for now is only a test for a short period of time on a small percentage of Yahoo’s search results. (Text of the release after the jump, along with Microsoft’s response, but Yahoo’s saying it involves 3% of search queries in the U.S., for two weeks.)

Analysts have long pointed out that Yahoo could jack up its profits overnight by outsourcing its search advertising to Google, which generates much more revenue per search than Yahoo. Indeed, such a deal has been rumored for at least the past year.

But the timing of this test, news of which the Wall Street Journal broke a few minutes before the announcement, is not coincidental. Sources said the test is part of the alternatives Yahoo has been exploring to counter Microsoft’s unsolicited bid for the company, which has ratcheted up in intensity the last few days. The test is clearly intended to show that Yahoo has not been sitting on its duff, as Microsoft’s letter to Yahoo’s board this weekend implied. So for several reasons, this announcement sounds like a prod at Microsoft to up its $31-a-share deal, which is now worth a couple of dollars less than that thanks to a drop in Microsoft’s stock since the Jan. 31 bid.

For one, the people who know about the announcement also emphasize that it’s only a small, short test, intended to find out how much more revenue Google ads could generate than Yahoo’s own. Also, Google already understands the regulatory problems it would run into with a larger Yahoo deal, which led it last year to cool on the idea. So a real deal seems rather unlikely.

Indeed, the sources suggest the test shouldn’t interfere with the possibility of reaching a deal with Microsoft, a deal that both analysts and most investors assume will happen before too long. Of course, any kind of significant deal with Google clearly would interfere with a Microsoft deal. So I read into this less an intention on the part of Yahoo to do a deal it has repeatedly shied away from, despite many chances to do it, than a bargaining chip to extract a better price from Microsoft.

Microsoft, in its response, in full after the jump, sounds unimpressed. Though it apparently was impressed enough to let Wisconsin Sen. Herb Kohl, chairman of the Senate Judiciary Committee’s Subcommittee on Antitrust, Competition Policy and Consumer Rights, know about it fast enough to issue this statement less than two hours after the announcement: “We will be following closely the results of the short-term test alliance between Yahoo! and Google. Should there be moves to make this agreement permanent, we will examine it closely in the Antitrust Subcommittee to ensure that it does not harm competition. Following closely on the heels of Google’s acquisition of DoubleClick, this Google-Yahoo alliance would represent even further consolidation in the internet advertising market.”

But if this test—potentially within the three-week window Microsoft set up to launch a proxy fight—pans out and Yahoo also manages to come through with a first-quarter report on Apr. 22 that looks stronger than the current low expectations of analysts, suddenly Yahoo will have some leverage it didn’t have before. If the quarter tanks, though, advantage goes back to Microsoft.

Either way, a Microsoft-Yahoo deal probably still gets done. The main uncertainty remains, as it has from the start, not if the deal will get done, but for how much.

Here's the Yahoo press release:

Yahoo! to Conduct Limited U.S. Test of Google's AdSense for Search Service

SUNNYVALE, Calif., Apr 09, 2008 (BUSINESS WIRE) -- Yahoo! Inc. (Nasdaq:YHOO), a leading global Internet company, announced today that it will begin a limited test of Google Inc.'s AdSense for Search service, which will deliver relevant Google ads alongside Yahoo!'s own search results. The test will apply only to traffic from in the U.S. and will not include Yahoo!'s extended network of affiliate or premium publisher partners. The test is expected to last up to two weeks and will be limited to no more than 3% of Yahoo! search queries.

As previously announced, Yahoo!'s board of directors is exploring strategic alternatives to maximize stockholder value, including exploration of potential commercial business arrangements. The Company noted that the testing does not necessarily mean that Yahoo! will join the AdSense for Search program or that any further commercial relationship with Google will result. The Company further stated that it would not comment on the nature or timing of any potential relationship.

And here's Microsoft's response, from general counsel Brad Smith:

Any definitive agreement between Yahoo! and Google would consolidate over 90% of the search advertising market in Google’s hands. This would make the market far less competitive, in sharp contrast to our own proposal to acquire Yahoo! We will assess closely all of our options. Our proposal remains the only alternative put forward that offers Yahoo! shareholders full and fair value for their shares, gives every shareholder a vote on the future of the company, and enhances choice for content creators, advertisers, and consumers.

In other words: You're not fooling us, Yahoo. The deal stands, until you come to the table on our terms.

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