Can Yahoo Terminate Its Partnership With Microsoft’s Bing?

In 2009, Yahoo! (NASDAQ:YHOO) forged an alliance with Microsoft’s Bing search engine to power its search results and monetize the traffic on Yahoo properties more effectively. However, since January 2012, Yahoo’s search market share in the U.S. has declined from 14.1% to 11.8% in March 2013, as web browsers prefer Google‘s(NASDAQ:GOOG) search engine over Bing. ^[1]

According to our estimates, the search ads segment is the biggest of Yahoo’s operating segments and makes up approximately 14% of the company’s value. It also accounts for more than a third of Yahoo’s total revenue. In Q1 CY13, search ad revenues excluding-traffic acquisition costs (TAC) increased by over 6% to $408 million. Although, Yahoo has reported consistent growth in search ads revenue in the past quarters due to increase in web traffic across its properties, its revenue per search (RPS), a key driver for search ads revenue, continues to lag behind industry benchmarks. ^[2] This indicates that the Yahoo-Bing partnership has failed to monetize the search ads on Yahoo effectively.

According to a recent article published by the Wall Street Journal, Yahoo is looking at avenues to exit this partnership. However, we are of the view that it will be difficult for Yahoo to terminate this collaboration.

See our complete analysis of Yahoo! here

The Partnership With Bing

Yahoo and Microsoft announced their search alliance in July 2009, which came into effect in 2010. According to the terms of the 10-year deal, Yahoo will receive 88% of the revenues from search ads that appear next to search results on Yahoo’s websites. Moreover, Microsoft guarantees a certain level of revenue for every search query done on Yahoo’s sites for the first three years, so as to limit the loss in revenue during the transition to Bing’s search technology. This guarantee expired at the end of Q1 CY13, and has since been extended for an additional 12 months period. While Yahoo’s search market share has suffered, Microsoft’s market share has increased to 16.8% in March 2013, from 15.2% in January 2012, due to this partnership and technology transfer from Yahoo. ^[3]

Easy Exit Not In Sight

Yahoo is losing revenues as its search market share is shrinking. We believe that it will be difficult for Yahoo to terminate its contract with Microsoft until at least mid-2015, the midway point of the 10-year agreement when either party can potentially opt out. Moreover, Yahoo can also sever the contract if the revenue per search falls below a certain level, but with recent renewal of revenue guarantee from Microsoft we expect that the RPS will stay above this predefined level.

However, according to our estimates RPS for Yahoo rebounded in 2012 to $13.7 from ~12 at the end of 2011. The primary reasons for this were buoyant economic outlook and increased ad spend on online advertisements. According to IAB, annual Internet advertising revenue increased by over 15% y-o-y to $31.6 billion in the U.S. in 2012, as advertisers increased their ad budgets for online media. ^[4] We expect RPS will decline marginally to $13.2 by the end our forecast period, but still remain above the guaranteed RPS level. We believe it will be difficult for Yahoo to terminate its partnership due to substantial decline in RPS.

Yahoo can also break the deal if Microsoft sold Bing, something the company considered doing last year. However, Microsoft has no potential suitors for its money losing online business, which posted an operational loss of $218 million in Q1 CY13.

Even if Yahoo were to terminate this partnership, it will have to either undertake the arduous task of developing its own search technology, or negotiate the regulatory compliance and forge an alliance with Google. We believe that this will affect Yahoo’s revenues since either developing new search technology or gaining necessary regulatory approvals will consume time, and during the transition period Yahoo might lost out on its the search ads business.

Conclusion

The easiest way forward right now seems to stay the course as alternative options look too costly. However, if Yahoo does terminate its partnership and transitions to an alternate search platform, it might lead to growth by minimizing the gap between industry RPS and Yahoo’s RPS. We will look for updates from Yahoo for potential steps that could address this issue.

We currently have a $23 price estimate for Yahoo, which is approximately 15% below its current market price.

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1. comScore Releases March 2013 U.S. Search Engine Rankings, April 12 2013, www.comscore.com [↩]
2. Earnings Transcripts, April 16 2013, www.seekingalpha.com [↩]
3. comScore Releases January 2012 U.S. Search Engine Rankings, February 9 2012, www.prnewswire.com [↩]
4. Record Breaking Quarter: Digital Ad Revenues Cross $10 Billion Mark For The First Time, April 16 2013, www.marketingland.com [↩]