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SAN FRANCISCO -- A search deal between





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now faces the scrutiny of European regulators, casting new doubt on its prospects.

The European Union is known for its tough anti-trust stance, which has resulted in fines against


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in the past. If regulators decide to formally challenge the Yahoo!-Google deal, that could result in a delay of up to a year, or even a collapse of the search deal altogether.

On Tuesday, Google issued a statement in response to the European Union's probe: "The agreement is limited in scope to Yahoo's U.S. and Canadian websites, and it will not have any significant effect on Europe. We are of course co-operating with the Commission and are confident that they will reach the same conclusion."

Yahoo! also emphasized its cooperation with regulators in its own statement: "Yahoo! has been and will continue to work with the relevant regulatory agencies to provide officials with the necessary information about this business agreement, which we believe will strengthen competition in search and make advertisements more relevant for our users."

Yahoo! reached the search deal with Google in June as a way to stave off a Microsoft takeover. The arrangement allows Yahoo! to outsource some of its online ads that run along its search engine to Google, which in turn shares the revenues generated from the ads with Yahoo!.

Yahoo! has touted the plan as a major revenue driver, potentially generating $800 million a year in sales. Without it, the company would have a hard time justifying to shareholders why it had turned down Microsoft's offer to purchase the company for $33 a share earlier this year. It could also put pressure on Yahoo! to bring Microsoft back to the table for a new round of talks.

Jeffrey Lindsay, an analyst for Sanford Bernstein, estimates that the Yahoo!-Google deal would only add about $3 a share to Yahoo!'s stock, whereas a Microsoft-Yahoo! merger could add $6 to $7 a share.

"If the U.S. or Europe block or delay (the Yahoo!-Google search deal), it puts (Yahoo!) back in play with Microsoft," Lindsay says. "The major shareholders would definitely be interested in reopening talks with Microsoft and obviously Microsoft still has an interest in improving its performance in paid search."

Yahoo's shares now trade at about $19 -- about the same level it had hovered before Microsoft made its original bid. The stock had climbed as high as $29 when a deal with Microsoft seemed likely but then plummeted when negotiations ended.

Lindsay acknowledges that a deal between Microsoft and Yahoo! would inevitably draw the attention of European regulators as well, especially given Microsoft's track record with them. But he maintains that there is a higher likelihood of it passing muster over a Yahoo!-Google deal in light of Google's dominance in the search market.

Google makes up about 60% of the search share market in the U.S., compared to 20% for Yahoo! and 9% for Microsoft, according to research firm comScore.

Gary Reback, an attorney for Palo Alto, Calif.-based Carr & Ferrell, says the prevailing philosophy among regulators is that three competitors in marketplace will always be better than two. So the question is, will a search deal with Google strengthen Yahoo! enough to make it a formidable competitor, or will it increase Google's dominance and leave Microsoft as the only rival in the search space?

For their part, Yahoo! and Google may have sought to avoid the European Union's involvement by limiting their search deal to the U.S. and Canada. But since both companies have sizeable operations in Europe, regulators there now have cause to look into the arrangement.

The additional scrutiny comes as the U.S.

Justice Department

also delves deeper into the deal. Last week, it hired top attorney Sanford Litvack to examine any evidence collected so far that might raise anti-trust concerns. Attorneys general from several states have raised questions as well, along with the Association of National Advertisers, which claims the deal could undermine competition and lead to higher ad prices.

This by no means indicates that either the European Union or the Justice Department will try to unravel the deal. But it does give pause to anyone who might have thought it would be a slam dunk.

Google's Chief Executive Eric Schmidt has said that the two companies plan to move forward with the deal early next month even if regulators haven't taken any action by then. Regulatory approval is not required on the deal, however, the government can still challenge it on anti-trust grounds.

Reback says the main difference between U.S. regulators looking into the case and. European regulators is that European regulators tend to take anti-trust matters more seriously.

"It's another level of difficulty for the deal," Reback says.