Google Ends Search Advertising Deal with Yahoo

On Wednesday, after much speculation Google (GOOG) ended its controversial Internet search advertising deal with Yahoo (YHOO) that was originally announced in June of this year. Mountain View, Calif.-based Google described the departure as being amicable and recognized the fact that the deal was canceled as result of pressure from US regulators.

Apparently, Google didn’t have much choice but to withdraw from the pact to avoid having a tediously protracted legal battle with US regulators. The Justice Department, in a statement issued on Wednesday, said it had told internet’s search giant that it planned to file a lawsuit to block the implementation of the deal on antitrust grounds. The partnership would have created a high concentration of market power into one entity.

Had the companies implemented their arrangement, Yahoo’s competition likely would have been blunted immediately with respect to the search pages that Yahoo chose to fill with ads sold by Google rather than its own ads, and Yahoo! would have had significantly reduced incentives to invest in areas of its search advertising business where outsourcing ads to Google made financial sense for Yahoo, the Justice Department said.

Last week both search giants scaled back the terms of their search advertising deal in what looked like a last-ditch attempt to get approval from US regulators. Some analysts called it the Band-Aid deal, while others said it smacks of desperation.

Yahoo meanwhile, sees Google’s walking away from the agreement with dissatisfaction. The company in a statement expressed its disappointment that Google had “elected to withdraw from the agreement rather than defend it in court.” For Yahoo this is another major blow since it had expected to earn up to $450 million in operating cash flow annually from the deal.

Google from its part reiterated the fact that it would not allow the prospect of a legal fight to distract it from its core mission. The co. is the runaway leader in Internet search advertising. Yahoo is a distant second.

Here is the full statement by Google’s Senior Vice President, Corporate Development and Chief Legal Officer David Drummond on the matter:

In June we announced an advertising agreement with Yahoo! that gave Yahoo! the option of using Google to provide ads on its websites (and its publisher partners’ sites) in the U.S. and Canada. At the same time, both companies agreed to delay implementation of the agreement to give regulators the chance to review it. While this wasn’t legally necessary, we thought it was the right thing to do because Google and Yahoo! have been successful in online advertising and we realized that any cooperation between us would attract attention.

We feel that the agreement would have been good for publishers, advertisers, and users—as well, of course, for Yahoo! and Google (NSDQ: GOOG). Why? Because it would have allowed Yahoo! (and its existing publisher partners) to show more relevant ads for queries that currently generate few or no advertisements. Better ads are more useful for users, more efficient for advertisers, and more valuable for publishers.

However, after four months of review, including discussions of various possible changes to the agreement, it’s clear that government regulators and some advertisers continue to have concerns about the agreement. Pressing ahead risked not only a protracted legal battle but also damage to relationships with valued partners. That wouldn’t have been in the long-term interests of Google or our users, so we have decided to end the agreement.

We’re of course disappointed that this deal won’t be moving ahead. But we’re not going to let the prospect of a lengthy legal battle distract us from our core mission. That would be like trying to drive down the road of innovation with the parking brake on. Google’s continued success depends on staying focused on what we do best: creating useful products for our users and partners.

YHOO is currently at $14.30/share up about 7% in midday trading rtq, likely on the expectation of Microsoft (MSFT) returning with a new deal.

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