A Chill Fills Search Space

Updated from 3:47 p.m. EST

What if search isn't as rich a gold mine as everyone thinks it is?

It's a valid question, and one that is on the minds of many investors Thursday after a key stock analyst put the brakes on his optimism about revenue growth at Google and Yahoo!.

Google was trading down 3.3% at $187.54, and Yahoo! was down 4.5% at $30.69 in Wednesday trading after RBC Capital Markets' Jordan Rohan cut his rating on the two stocks to sector perform. Rohan had been running with the search-engine bulls, having rated Google a top pick and Yahoo! outperform.

Now he rates Google outperform, lowering the price target for the stock to $200 from $250. Yahoo! has been downgraded to sector perform with a new price target of $34, down from $43.

So what changed? Rohan says he's been watching the pricing trends among the sponsored-search links that usually appear in the right-hand column when users type in a search term on Google and Yahoo! (The main column consists of "natural search" results -- unpaid for and ranked by algorithms to reflect the most linked-to Web pages.) In the first half of the fourth quarter, search prices are down by a double-digit figure at Google and down as much as 20% at Yahoo! Yahoo! relies on search revenue from its Overture unit for 40% of its revenue.

"We have assumed that the pricing trends improve during March but close the quarter at an 8% sequential decrease from 4Q04," Rohan wrote in his note on Google. He did not give an estimate for Yahoo!'s first-quarter pricing.

That would be a stark shift from what Rohan called a "robust" pricing environment in the fourth quarter of 2004, when comparison-shopping sites such as Shopping.com and Shopzilla were spending heavily to get as close to the top of the sponsored-link lists as they could. The more established online retailers such as eBay and Amazon.com were also caught up in the pricing frenzy.