Maybe The Search Engine Business Isn’t So Great (YHOO)(GOOG)(MSFT)

Several studies show that Microsoft’s (NASDAQ:MSFT) Bing search engine picked up market share in October. Combined with Yahoo! the two companies could end up with clost to 30% of the industry in the United States. The firms believe that the deal will be final in the first quarter of next year. Google (NASDAQ:GOOG) will still have two-thirds of the market, but perhaps second place is not so bad.

The value of first place is hard to argue. Google has a market capitalization of $180 billion and had operating income of $2 billion on revenue of slightly less than $6 billion last quarter. Yahoo! serves about 20% of the searchs made in the US but has a market cap of only $23 billion and made a very modest $70 million on $1.78 billion in revenue in the period ending September 30. Microsoft does not break out its search revenue or expense, but its online operations are small and lose money.

Bing has some momemtun now and the deal it has put together to marry its search business with Yahoo! may no longer look as good it did when the tranaction was first announced. The final agreement seems to be taking a long time to close. Maybe someong has cold feet.

Bing and Yahoo! together will not be a very big operation. The search joint venture is unlikely to have revenue of better than $2.5 billion a quarter, as measured as if it were its own company. Cost cutting should make it fairly profitable, but the bottom line is unlikely to be any better than $350 million a quarter, a small fraction of what Google makes.

Google has a scale and profit advantage over its competition for several reasons but the most important is that the more searches a search engine does, the more accurate the results are for both consumers and advertisers. Google works at an order of magnitude the its competition can image but cannot come close to matching.

Microsoft says that search is a “strategic” business, a weapon of sorts against Google and other competitors. It is not entirely clear why that is true. Perhaps it is because Google has something that Microsoft does not, but the Google’s leverage from that, beyond making a lot of money, is not clear. Search does not appear to be critical to Oracle (NASDAQ:ORCL) or SAP (NYSE:SAP), the two largest enterprise sofware companies in the world. Microsoft must be a special situation, but it has not necessarily made a powerful case of why.

Sometime next year, the Yahoo! deal with Microsoft will probably be approved by regulators. Putting the search operations of the two companies involves substantial risks as all large corporate integrations do. Google is going to take advantage of any disruption in the service of its two competitor. Microsoft gets an edge in the tech world because of its joint venture with Yahoo!, but that edge is an obscure one. The two firms together get a mediocre business.

Douglas A. McIntyre