Microsoft Deal to Boost Yahoo’s Search Advertising Margins

by Trefis Team
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The 10-year Internet search partnership between Yahoo (NASDAQ:YHOO) and Microsoft (NASDAQ:MSFT) has been approved by US and European regulators.  The partnership is expected to pose a serious challenge to Google (NASDAQ:GOOG), which leads the search market with 65% share.  In comparison, Yahoo and Microsoft’s Bing have small shares of 10% and 8%, respectively.

Below we discuss the significance of search advertising for Yahoo’s stock and why we expect the Microsoft deal to boost Yahoo’s EBITDA margins.

Search advertising 25% of Yahoo’s stock

We estimate that the search advertising business constitutes 25% of the $20.58 Trefis price estimate for Yahoo’s stock.  Yahoo’s search business makes money from contextual advertising known as keyword advertising that is generated to match the type of search a user conducts. For example, a user searching for “restaurants NYC” would be shown a variety of advertisements on the right-hand side of Yahoo search results pertaining to restaurants and food services in New York City.

Search Advertising is the most valuable division of Yahoo. Advertisers on Yahoo bid for keywords (such as “restaurant”, “NYC”) to display their advertisements. The pricing of keywords, the inventory of keywords available, and the frequency of user search impact how much money Yahoo makes on search.

Microsoft deal will improve Yahoo’s EBITDA margins

Through the Microsoft deal, Yahoo is expected to make more money as Yahoo is allowed to keep 88% of revenue from search ads on its website for the first five years, while Microsoft absorbs most of the expenses. We expect Yahoo’s Search Advertising EBITDA margins to improve from the present 42% to around 45% by the end of Trefis forecast period.

You can modify our forecast below to see how Yahoo’s stock would be impacted if its EBITDA margins for Search Advertising were to remain stagnant rather than increase as we forecast.

For additional analysis and forecasts, here is our complete model for Yahoo’s stock.

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