Wall St. found a lot of things wrong with the joint venture in the search engine industry between Microsoft (MSFT) and Yahoo! (YHOO)

The smaller company’s stock dropped 12% and analysts felt that it was particularly badly served by the actions of its relatively new CEO Carol Bartz. Investors wanted Microsoft to pay upfront for the privilege of having access to Yahoo!’s 20% of the US market. Rumors were that Yahoo! would get a lump sum of $2 billion at closing, and instead, it got nothing.

The financial expectations are that Yahoo! will have a $500 million a year operating income benefit from the transaction. The portal company has been struggling for three years as Google (GOOG) has progressively taken its share of the search market away. Yahoo!’s stock has lost almost half of its value during the last five years. Google is up over 300% for the same time frame.

Some analysts believe that the deal, which is set for ten years, is too long. Yahoo! will be badly injured if the expected benefits don’t materialize. Another way to look at the issue is that Yahoo! has arguably the strongest technology company in the world as a protector, even if Microsoft has lost some of its power since Google began its ascendancy. Microsoft’s new grip on Yahoo! may be a little tight, but that is better than the company having to exist independently, since it had only $131 million in operating income last quarter and lost 13% of its revenue.
The most incisive criticism of the partnership is that it will take several months to close and nearly two years for Yahoo! to receive its full financial benefit.  A lot can go wrong in two years, and Google may try to use this period, as the press has pointed out, to gain ground while its two rivals are bogged down with integration problems.

The Microsoft deal with Yahoo! is not a merger or an acquisition, but from an integration standpoint, it might as well be. The transaction involves two cultures, two technology platforms, and two firms which have very different goals. Yahoo! is a search company with an internet portal built on top of it. Microsoft looks at the search engine as a strategic piece necessary for it to remain the world’s largest software company. Search is a corridor for Microsoft. It makes its operating systems for PCs, wireless devices, and endless consumer and business hardware platforms more functional. Microsoft loses ground when its clients use its software and Google’s search products. Microsoft has to operate in an environment where its most dangerous competitor is a part of almost every market that Redmond wants to dominate. Microsoft’s alliance with Yahoo! gives it a modest but reasonable chance to take the battle for internet supremacy to Google. For the last few years, most of the initiative and momentum in the tech world have belonged to the huge and growing search firm.

The two most famous studies of the effectiveness of M&A were done by McKinsey and KPMG. McKinsey said 74% of deals fail to create additional shareholder value. KPMG said the number was 83%. The Yahoo! search engine partnership with Microsoft is a merger of sorts, whether the firms want to admit that or not.

The greatest asset in a merger is probably a strong and skilled person to run the integration and the integrated company when the work of putting two operations together is done. The Microsoft deal with Yahoo! does not have that. The companies did not name a chief executive of search. The people responsible for making the partnership a success are all lieutenants. Carol Bartz will spend a great deal of her time on the process, but she has a lot of trouble now just handling  Yahoo!’s portal and online display ad businesses. And, Yahoo! is the junior partner in the Microsoft deal, by far the smaller of the two companies making Bartz and unlikely candidate to supervise the marriage. Steve Ballmer runs a company that has lost much of its edge. It is still dominant in the PC operating system business, but its business and server units are being challenged by open source Linux and powerful corporations that cater to enterprise clients, especially Oracle (ORCL) and SAP (SAP). Ballmer should be in charge of the integration, but he does not have the time. He will have to manage the process with his left hand, which is already busy with his company’s game division which makes the Xbox and the company’s internet division which owns MSN.

The new Yahoo!/Microsoft business has a lot of rough sea ahead of it and no one in place to captain the ship.

Douglas A. McIntyre

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