THE DAY AHEAD: Net2Phone deal bad precedent for Yahoo

COMMENTARY--Yahoo's revised deal with Net2Phone poses a series of significant "What ifs?" The most notable one is: What happens if Yahoo has to start paying its third party content and service providers?

On Tuesday, Internet telephone service provider Net2Phone reported its earnings and said it will move up its break-even target. As part of its goal to become profitable, Net2Phone also said it would restructure its portal pact with Yahoo (Nasdaq: YHOO).

Yahoo (gasp!) will have to pay Net2Phone (Nasdaq: NTOP) for its Net telephony technology, which has become quite popular on the portal. Under its revised agreement, Yahoo will purchase Internet protocol-based voice and enhanced services from Net2Phone to be used for its voice portal, messaging and other telephony-based services. The original agreement had Net2Phone paying Yahoo for exclusivity.

Now this reversal wouldn't be shocking to anyone who happened to miss the dot-com boom. If you provide a service or something proprietary, you usually get paid for it.

But that's not how it worked in the good ol' dot-com days, and Yahoo's business model was built on a scheme where third parties paid Yahoo to give away their content and services.

Yahoo, one of the biggest properties on the Internet, has eyeballs, lots of them. So smaller fish in the food chain paid the portal company gobs of dough to get distribution.

Now that Yahoo is struggling to court traditional advertisers and grow sales again, many partners may be itching to restructure deals. Technically, Yahoo doesn't offer anything proprietary. Most of its services are replicated elsewhere, and Yahoo's content is fueled by third parties. Yahoo provides an experience, one that was profitable until the ad market imploded.

Without subscription revenue and proprietary content like AOL Time Warner (NYSE: AOL), Yahoo finds itself in a tough spot, one that will get tougher if it has to start paying third parties.

That's why the Net2Phone deal deserves more than a passing mention. Net2Phone could be kicking off a series of restructured deals where Yahoo has to pay content and service providers. And as broadband content becomes more popular, Yahoo is likely to have to pay high rates to get compelling content.

Yahoo hinted at such a possibility in its recent annual report. "Until recently, the majority of the content that we provided to our users was in print, picture or graphical format and was either created internally or licensed to us by third parties for little or no charge," the company said.

As Yahoo offers increasing amounts of audio and video users, the company may have to make "substantial payments to third parties."

The implications of what happens to Yahoo if the tables are turned on its partnerships were not lost on Arthur Newman, an analyst at ABN Amro.

"Yahoo relies on a variety of similar providers for a portion of its enhanced services and may find itself paying for such services, something it might not have done a year ago," he wrote in a research note referring to the Net2Phone deal. "As these providers come under pressure to produce profits, and in some cases survive, we believe other deals could be renegotiated, putting pressure on Yahoo's profitability."

And content partners may also follow Net2Phone's lead. "Existing content providers might continue to revise existing arrangements to receive, rather than make, payments to Yahoo," Newman said.

That switch would be damaging. Sure, Yahoo pays the Associated Press and Reuters for feeds, but content providers such as BusinessWeek, Forbes and TheStreet.com often give Yahoo sweetheart deals for exposure and distribution. It only takes one restructured content provider deal to open the door for more.

In the end, any type of proprietary content arrangement could be open to renegotiations. After all, Yahoo's pacts with third parties usually aren't long-term deals. Rob Martin, an analyst with Friedman Billings Ramsey, said Yahoo could find itself with a cable television model, where the portal pays for all of its proprietary content. The problem is that Yahoo doesn't have subscription fees to offset payments.

As this trend evolves, you're likely to see two eventual outcomes: Yahoo begins to acquire proprietary content, or the portal starts paying up and the financials become even more murky. TDAIN
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