Google Earnings May Give Yahoo Leverage

An earnings windfall for Google should benefit rival Yahoo in buyout talks with Microsoft, as investors view the results as proof of a robust online advertising market.

Paul Sakuma / AP

Yahoo is entering a critical week as it prepares to report quarterly results on Tuesday and faces a Microsoft-imposed deadline on Saturday to accept the nearly $43 billion offer.

The software maker has cast doubt on whether Yahoo is even worth that much with a weakening U.S. economy and general slowness in the ad industry. Google's strong showing could help its rival Yahoo stand firm on a higher takeover price on hopes Web marketing is more durable in a downturn.

Industry analysts say Yahoo's first-quarter results are
going to be a major swing factor in its talks with Microsoft.

"The one thing that can really change Microsoft's thought process on valuation is if they can come in with good results," said Ross Sandler, analyst at RBC Capital Markets. "We think there is a decent likelihood of upside from Yahoo this quarter."

Yahoo's forecast pegs first-quarter net revenue between $1.28 billion and $1.38 billion. Analysts, on average, are expecting a profit of 9 cents a share, excluding special items, on revenue of $1.32 billion, according to Reuters Estimates.

Google on Thursday reported a better-than-expected profit and revenue growth of 42 percent. It said client spending had not been hurt by economic concerns, sending its shares up
nearly 20 percent to $538.43 on Friday. Yahoo rose 1.7 percent to $28.51.

"In terms of today and next week, there's going to be a lot of upward momentum for all of the Internet companies" who rely on ad revenue, Sandler said.

For example, Internet conglomerate IAC/InterActiveCorp shares rose 2.8 percent, while online marketing firm ValueClick gained more than 8 percent.
    
Google Chief Executive Eric Schmidt said his team had carefully reviewed scenarios regarding the economy, and concluded that even if conditions worsened, its search advertising would still attract companies as an efficient way to reach customers.

"This signals that the online advertising market is still healthy, which should help Yahoo get a better price for its company," said Peter Dunay, chief investment strategist at Meridian Equity Partners.

Internet advertising executives bolstered Schmidt's rosy view, saying their clients were actually spending more money online at both Google and Yahoo.

"We have had a handful of clients come to us knowing there is a downturn who are actually looking at it as an opportunity to increase [market] share," said Kelly Twohig, senior vice
president at Starcom USA, who manages the agency's digital media buying. Starcom is part of Publicis.

Part of the rationale is that consumers who find their home budgets shrinking will be more zealous in seeking out information on products and comparison shopping online.

That makes the Web a more important place for companies to hawk their brands, even if they cut advertising elsewhere.

"You might see brand budgets pulled back, but I do think that search is really still set to grow," said Sarah Fay, CEO of the Aegis Group agencies Isobar and Carat USA.

"Search is still being adopted by many of the companies that haven't used it heavily, especially companies in the consumer packaged goods space," she said.

For its own part, Yahoo has pulled out all the stops in trying to convince Microsoft it is worth more, including dizzying rounds of talks with potential partners for a merger or new venture, from Google itself to Time Warner's AOL and News .

Some of the talks involve outsourcing Yahoo's search to Google, a move expected to draw regulatory scrutiny as it could nearly eliminate any alternatives to Google's search network.

But analysts say no alternate-deal plan could force Microsoft's hand more than a major Yahoo earnings beat.

"That's what we call the most powerful trump card they can play," Sandler said.

© 2008 CNBC