What Yahoo's results tell us

Lesson 1 from the Yahoo report -- don't buy or sell stock based solely on comScore numbers. Ha!

Lesson 2? That's a bit more complicated. Everyone looking for clues into the next act of the Yahoo-Microsoft takeover saga can find plenty of weak numbers to chew on in Yahoo's first-quarter earnings report.

The weakness in search ads for the financial, travel and retail sectors suggest that the Internet's biggest display ad seller (at least for now) may have trouble hitting its forecast if the U.S. economy continues to weaken.

The relative weakness of ad sales from its partner sites, compared to its own Yahoo sites, continues a trend we've reported on for some time -- that smaller, vertically-focused ad networks are taking an ever-larger share of ad buyer's dollars.

The trend is likely to benefit startups like Adify, The Rubicon Project, Clickable and others. 

That problem is one that Yahoo shares with Google, which got twice the revenue growth from its own sites as it did from partner sites, thanks to a click-through rate that was much stronger than what some had feared from the earlier comScore numbers.

But the most important number in the Yahoo Q1 earnings report is the one right near the top line -- its revenue growth of 11% is a fraction of Google's 42% year-over-year growth (including traffic acquisition costs.

We relate these numbers in case anyone still thinks Steve Ballmer wants to buy Yahoo for its search ad business. Microsoft investors should hope not, because at the rate Yahoo is losing market share, he's buying a business that will be a relatively smaller player every quarter that goes by. 

That's why the potential that Yahoo might outsource search ads to Google, which analysts have suggested for some time and which Yahoo says it will experiment with, is more than just a tepid takeover defense. Yahoo may find higher margins that way by stopping its massive investment in search ad technology.

Ballmer doesn't want Yahoo's search ad business dependent on Google -- taking on Google across the ad market is the whole point of his takeover strategy. But given where the big money is going to be in online ads three years down the road, Ballmer wants Yahoo for its display ad business, which rose at a healthier 25% clip. Brand advertisers are warming back up to display ads now that they can be targeted based on user behavior, and Ballmer wants to combine MSN with Yahoo's properties and be the biggest dog in that game.

The biggest roadblock to that strategy is Google's acquisition of DoubleClick, which is going to vastly strengthen Google's hand in the online display ad business.

At first glance, it seems that Yahoo may be running out of time in its defense against Microsoft, because every quarter that goes by, it becomes a weaker No 2 player to Google in search. Without search, and still without a good social networking platform to monetize user-generated content, Yahoo is simply an online publisher with a cost basis far out of whack to its display ad business. Its forecast has failed to inspire.

The relative weakness of Yahoo's growth versus Google's makes you wonder about Microsoft's own search ad business. And the more quickly Google integrates DoubleClick, the more likely it will be running before any Microsoft-aQuantive-Yahoo-RightMedia amalgamation learns to find its feet among ad buyers.

As I've said over and over, paying anywhere close to $40 billion for Yahoo is too much because it doesn't solve the strategic problem (i.e., Google) that Ballmer needs it two. Even if Ballmer can turn the combined company into an online media behemoth, he'll have plenty of company in that market as well, including NewsCorp., Disney and others. 

The takeover battle could take quite a long time if Microsoft launches a proxy fight, as it's warned. But neither player holds a particularly strong hand at the table, which means shareholders of the two companies -- many of them now arbitrage players -- could play a decisive role in determining what Yahoo is worth.