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Originally published Thursday, November 6, 2008 at 12:00 AM

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Google pulls out of Yahoo ad deal; is Microsoft in?

Google tossed floundering Internet rival Yahoo a life preserver four months ago when the two agreed to a search advertising deal. But with federal regulators ready to challenge the plan on antitrust grounds, Google abruptly cut the rope Wednesday, setting Yahoo adrift again.

Los Angeles Times

Google tossed floundering Internet rival Yahoo a life preserver four months ago when the two agreed to a search advertising deal. But with federal regulators ready to challenge the plan on antitrust grounds, Google abruptly cut the rope Wednesday, setting Yahoo adrift again.

And, just as earlier this year, there may be a shark circling Yahoo in the water: Microsoft.

Yahoo has shrinking options for a rescue that would help the 15-year-old company remain independent, and Chief Executive Jerry Yang's job is in trouble, analysts said.

But Yahoo's stock rose as much as 11 percent Wednesday on speculation that Microsoft would make another bid for its search business. The stock closed up 57 cents, or 4 percent, at $13.92.

"The loss of the Google deal is going to cause cascading problems for Yahoo," said Sanford C. Bernstein analyst Jeffrey Lindsay. "It's hard to see how Jerry Yang survives it."

Yahoo's hopes of boosting its annual revenue by $800 million through the Google partnership were torpedoed by the concerns of Justice Department antitrust officials, who argued that the deal would erode competition in the online advertising market.

"The arrangement likely would have denied consumers the benefits of competition: lower prices, better service and greater innovation," said Thomas O. Barnett, who oversees the department's antitrust division.

Google had much less at stake in the deal than Yahoo. With one goal already accomplished — staving off a Microsoft acquisition of Yahoo — Google executives canceled the deal after the Justice Department told them it was headed to court to block it.

Dominance in spotlight

But Google may not have emerged unscathed. The antitrust review and opposition to the Yahoo deal, stirred up by Microsoft, have led to a deep awareness — and growing concern — by regulators of Google's online dominance.

Rebecca Arbogast, an analyst with brokerage Stifel, Nicolaus, said scrutiny is not welcome, "just like one never wants to have an IRS audit, even if you haven't done anything wrong."

Google said it believed the agreement would have been good for Internet users, advertisers and publishers.

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"However, after four months of review ... it's clear that government regulators and some advertisers continue to have concerns about the agreement," said David Drummond, Google's chief legal officer and senior vice president for corporate development.

"Pressing ahead risked not only a protracted legal battle but also damage to relationships with valued partners."

The deal was announced June 12, the same day Yahoo and Microsoft ended five months of unsuccessful talks on a merger or partnership, including an unsolicited $31-a-share offer from the software giant in February.

Google agreed to broker some text ads for Yahoo's search engine, which Yahoo hoped would appease investors by boosting its profitability.

The companies agreed to delay implementation to address antitrust concerns raised by a partnership between the two top search engines.

The Justice Department said its review determined Google and Yahoo would "become collaborators rather than competitors for a significant portion of their search advertising business."

Over the past two months, Google and Yahoo offered to narrow the deal's length and scope to address the concerns. But the Justice Department decided those changes weren't enough.

"Everyone recognized that Yahoo was committing itself to a very costly addiction in return for this flood of Google dollars," said Jeffrey Chester, executive director of the Center for Digital Democracy, one of several groups that opposed the deal, including the Association of National Advertisers and the World Association of Newspapers.

"It would have become hooked and dependent on what is supposed to be its key competitor," Chester said.

Microsoft cheered the demise of what it called an "illegal deal," but the Redmond company would not comment on its interest in Yahoo. Chief Executive Steve Ballmer said last month that a search-related deal could make economic sense for both companies and there could be "continuing opportunities" for a partnership. But Microsoft said the same day it had "no interest in acquiring Yahoo."

Yang appears ready to talk. Wednesday evening, at the Web 2.0 summit in San Francisco, he said he was willing to sell his company to Microsoft if the software maker returns to the bargaining table, The Associated Press reported. "To this day, I believe the best thing for Microsoft to do is to buy Yahoo," Yang said.

Yahoo President Sue Decker told employees in an e-mail Wednesday that the company's future did not hinge on the Google partnership.

"While this turn of events is regrettable, it's important for all Yahoos to recognize that our agreement with Google was just one of many efforts that we have under way to accelerate our strategy," she said.

Analysts disagreed, saying Yahoo was in deep trouble now that Google had severed its lifeline.

Major pressures

Yang is under pressure to revive financial growth and boost its moribund stock, which has lost more than half its value since the co-founder took over as CEO in June 2007. He also has pursued a possible acquisition of AOL with its corporate parent Time Warner for nine months.

But those discussions, which would swap AOL for a percentage of Yahoo, have not progressed as both sides haggle over AOL's worth.

Without the extra revenue from Google, Yahoo probably couldn't meet AOL's asking price anyway, Lindsay said.

Meanwhile, Yahoo shareholders, along with new board member Carl Icahn, are pushing for renewed talks with Microsoft. And pressure may mount for management change.

Copyright © 2008 The Seattle Times Company

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