GOOGLE (TICKER: GOOG) AND Yahoo (YHOO) filed their agreement document with Securities and Exchange Commission last week, detailing their "text ad" deal. Though all financial terms were redacted, the details reveal a broader advertising deal that reaches beyond search advertising. We rate both Google and Yahoo at Buy.
Assuming the deal passes regulatory muster (not a given outcome), Google would serve not only search ads based on user queries but also ads on the content pages of Yahoo and its affiliate partners using Google's AdSense for Content (AFC) platform.
According to Yahoo management, content ads will typically be served on Yahoo's remnant inventory as well as on partner sites, including Yahoo's Newspaper Consortium. The contractual traffic-acquisition costs (TAC) paid to the partner sites will not change.
Yahoo could benefit from text ads on its non-search related remnant inventory.
The search-plus-content deal represents the best of both worlds for Yahoo since it should help it achieve better monetization on search and a higher sell-through/yield on under-monetized content.
Yahoo's management clarified that the $250 million-$450 million incremental operating cash flow (OCF) from the deal in fact assumes an "all-in" increase including the upside from search ads as well as incremental revenue from content ads on Yahoo and its affiliates.
Google should benefit from a substantial increase in its AFC inventory. At the midpoint of Yahoo's guidance of $250 million-$450 million in OCF, we estimate that Google should generate a minimum of $53 million of pretax income from this relationship (at 85% TAC), or an additional 12 cents in earnings per share to our fiscal 2009 estimates of $24.78. EPS consensus estimate stands at $24.17.
Despite the quid pro quo nature of the deal, we believe Google will benefit disproportionately from this deal over time given the enticing opportunity to take a peek under the hood at Yahoo's non-search business, and the possibility to leverage those insights to improve its growing display business.
If Google is able to provide better yield at the tail-end, Yahoo could face increased risk of affiliates migrating to Google over time.
Importantly, the broader deal with a search and non-search components could have a higher probability of clearing regulatory hurdles, in our opinion. Instead of denying a stand-alone search deal on the basis of Google's dominant search market share, the regulators will be forced to evaluate this broader advertising deal where no single company enjoys a significant market lead.