May 7, 2008 8:27 AM PDT

Yahoo to rake in $1 billion from Google ads? Doubtful

Posted by Stephen Shankland

Citigroup analyst Mark Mahaney has been widely cited for his February analysis showing some strong financial benefits of a deal under which Yahoo would use Google to supply search ads. With that scenario now appearing more likely, he's issued a new report on the subject that projects as much as $1 billion in incremental cash flow for Yahoo in 2008.

But that dramatic figure is based on a complete outsourcing of search ads to Google. So don't expect anything like that number to come of the potential pact, which could be announced this week. A source familiar with the plan describes it as more limited, not a wholesale outsourcing.

The overall Google ad deal is a balancing act for Yahoo. The more Yahoo relies on Google, the more financial benefit it stands to gain because Google's ads on average generate more revenue per click than Yahoo's. But more reliance also undermines Yahoo's in-house ad effort, raises the potential for antitrust concerns, and gives more ad-market clout to Yahoo's top rival--Google.

Cost savings is another factor. Without fully outsourcing, Yahoo doesn't get to trim payroll, research, and operational costs for its Panama system for selling text ads that show on search results.

So it seems judicious not to fixate on Mahaney's 100 percent outsourcing scenario, but on a lower one such as 25 percent, which he predicts will generate EBIDTA (earnings before interest, depreciation, taxes, and amortization) of $2.2 billion and cash flow of $251 million in 2008.

Henry Blodgett at Silicon Alley Insider also observes that any gains would increase the level of cash Yahoo would make, but it wouldn't be a steady, repeatable increase year after year--the kind of revenue growth Wall Street likes to see. His conclusion: outsourcing some ads to Google would be "smart," but not the "bombshell game-changer the Street is looking for."