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Yahoo's choices: Go it alone or cut a deal

The Internet pioneer can take the slow road of building its own business or try a major transaction for a quick fix. Here's a look at some of its options.

With Google deep-sixing its search-ad deal with Yahoo because of antitrust obstacles, what's next for the beleaguered Internet company?

Setting a new course isn't easy, of course, and Yahoo has less wiggle room without the the $800 million in annual revenue and $250 million to $450 million in new operating cash flow it said it expected during the first year of the Google deal. Now Yahoo has two basic options: continue with its internal efforts to improve its business, or enter into some sort of major transaction with the likes of AOL or Microsoft.

Judging by Yahoo's 5 percent stock price increase Wednesday, investors already had bid adieu to the money from Google and now are getting their hopes up for a major business transaction. Let's look at some of the possibilities for the company.

Yahoo headquarters in Sunnyvale, Calif.
Yahoo headquarters in Sunnyvale, Calif. Stephen Shankland/CNET News

AOL's online properties include a respectable display-ad business, a modest search-ad business currently powered by Google, and a variety of mainstream Web sites. But acquiring the company would hardly revolutionize Yahoo's business, and with all the overlap, integration would be complicated. What's appealing to shareholders about this prospect is the expectation that AOL parent company Time Warner would supply a good deal of cash--perhaps $2 billion by some estimates--while investing to take a major stake in Yahoo.

Microsoft is the more dramatic option, of course. With Yahoo's enfeebled stock price and Carl Icahn on its board, a Microsoft acquisition is still a possibility, even if Redmond has lost its earlier enthusiasm. But antitrust regulators showed some spine in effectively blocking the Yahoo-Google ad deal, and Microsoft already has a big red flag in Washington. By pooling their search-ad might, Microsoft and Yahoo still wouldn't catch up to Google, but the two might face criticism or resistance over merging their massive instant-messaging and mail operations.

Of course, the narrower acquisition of Yahoo's search-related assets would be a more manageable transaction. But given that Yahoo's search ad business was a relative bright spot in its third quarter, with graphical display ads suffering mightily at the hands of the economic turmoil, selling search would be hard.

Yahoo also has a number of assets in Asia it could sell. The falling stock market prices have diminished the value of those assets, but they're still considerable if Yahoo wants to find a buyer.

No deal?
After Google announced its decision to pull the plug on the partnership, Yahoo said it's focusing on improving its own core business--something it has to do regardless of whether there's a major business transaction.

Specifically, Yahoo called the Google deal merely "incremental" to Yahoo's plans, something that would have provided money to accelerate its plans but not something that changed "Yahoo's commitment to innovation and growth in search."

So what are those priorities? First is giving people a reason to go to Yahoo.

Here, Yahoo isn't so much concentrating on adding new properties as it is trying to get existing users to do more with Yahoo and to attract new users. Central to this push is Yahoo Open Strategy, an attempt to build social interactions into people's use of Yahoo, for example by sharing one Yahoo member's actions with his or her contacts. YOS also encourages the addition of third-party Web applications to Yahoo sites and the use of Yahoo data on others' sites.

YOS has the potential to fire up Yahoo's massive user base--142 million unique users from the U.S. in September, according to ComScore. But it's only being launched now, and it will take months for it to get up to speed, much less to win over Yahoo users and attract new ones.

The second big part of Yahoo's priority list is making money once users come, which for Yahoo, means advertising. But the market for display ads, the traditional graphical variety often used to promote brands, looks grim, and Yahoo's discussion of its involvement there involved a lot of optimism about positioning the company for growth once the market recovers rather than actual growth now.

Don't dismiss Yahoo out of hand, though, when it comes to advertising. The company has clout for online advertising, and it's just begun releasing a new technology called Apt that lets advertisers, publishers, and others join together at a larger scale for operations such as finding inventory where ads can be placed or selling ads for that inventory. Apt shows ads hosted by Google and by many hundreds of publishing partners.

A second ad factor for Yahoo is search. Most believe search ads to be less susceptible to recession-era spending cuts, and this business fared better in Yahoo's recent quarter even without a Google partnership. So no doubt this area is one of Yahoo's highest priorities. Google still dominates the search-ad market, though, and is making improvements of its own that gave it a downright rosy third quarter.

Google would have helped Yahoo's search-ad business, at least in the short run, by matching ads to search results where Yahoo's Panama technology couldn't. But the Google deal also illustrates the dangers of relying on your largest competitor for a major fraction of your revenue. The way the deal collapsed, with Google willing to scuttle it over Yahoo's objections, revealed that it can be hard to align competitors' priorities.

So, although Yahoo certainly isn't out of the woods and arguably is even deeper in, at least it isn't reliant on its rival's goodwill while choosing its next steps.