Microsoft tries to sell analysts on Yahoo deal

REDMOND, Wash. -- Microsoft Corp. CEO Steve Ballmer is trying to improve the bad feeling Yahoo Inc. investors have about the companies' search-advertising partnership.

Yahoo's shares plummeted 12 percent Wednesday after the deal was announced, and they continued dropping Thursday, ending 4 percent lower at $14.60.

Ballmer said he doesn't understand why.

"Nobody gets it," he said at a meeting of financial analysts at Microsoft headquarters.

Yahoo shareholders likely were hoping for a cash payment from Microsoft, which didn't end up happening. But the CEO said Yahoo investors should be pleased that the deal erases Yahoo's search costs and lets it keep 88 percent of the revenue from advertising sold alongside search results on its Web site.

Combining the two companies' search traffic will draw more advertisers, Ballmer argued. In turn, that should increase ad revenue for Microsoft and Yahoo, he said, because search ads are sold in an auction-style system in which marketers bid for the right to have their ad shown when a user enters certain search terms. As more advertisers make bids, the prices they pay figures to go up, Ballmer said.

Darren Chervitz, co-portfolio manager for the Jacob Internet Fund, which owns about 100,000 Yahoo shares, said Yahoo didn't get as much as it should have in the deal, considering that it has the Internet's second-most widely used search engine.

"It was a very disappointing conclusion to this two-year dance," Chervitz said. "I don't think they needed to do this deal unless the terms were incredible, and that's not the case here."

For all of Microsoft's efforts on improving its position in online search and advertising through the Yahoo deal, a much larger -- and more profitable -- chunk of its business is the Windows operating system, which saw its sales and operating profit fall about 30 percent in the last quarter.

Windows revenue has been hurt by the popularity of netbooks, or tiny, low-cost, low-power laptops, because most are sold with the older Windows XP system that's less profitable for Microsoft than the current Vista system.

The October launch of the new operating system, Windows 7, may help. The forthcoming system is supposed to work better than Vista on less-powerful computers. Ballmer said retailers can "upsell" netbook buyers to Windows 7, indicating Microsoft may be planning to charge computer makers more for it.

PC sales in developing countries also hurt Microsoft last quarter. Ballmer said that was because Microsoft was experimenting with charging less for Windows on the theory that it would increase overall sales.

"The theory was wrong," Ballmer said. With Windows 7, "we're going to readdress those prices north."

Ballmer also used the annual analyst gathering to let loose a few of his signature verbal tics. Netbooks? "Blah blah blah." The open-source Linux operating system? "Blah blah blah blah blah."

He also jokingly called out some of the analysts for using Apple laptops.

Microsoft shares ended up 1 cent at $23.81 Thursday.