As search giants

Google

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and

Yahoo!

(YHOO)

get ready to report earnings for the first quarter of 2005, a debate is growing over just how good -- or bad -- the environment has become for the glowing core of the nuclear reactor known as the Internet economy: search-related advertising.

Last year, the sponsored-link ads that appear on Google and Yahoo! search results, as well as a growing number of small-content sites such as blogs, generated growth at a rate that was faster than most areas of e-commerce. In the fourth quarter, sequential search-ad revenue grew 30% at Google and 16% at Yahoo!. But after

eBay

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, one of the biggest buyers of sponsored-link ads, said it was dialing back on its search spending, concerns arose that a small search bubble was about to pop.

On one side are analysts such Jordan Rohan at RBC Capital Markets, who downgraded Google and Yahoo! in February, and David Garrity of Caris & Co., who downgraded Google twice in the past six weeks. Rohan argued that not only is Google overvalued but also the current quarter is showing a surprisingly strong drop in search-related advertising, falling possibly more than 10% from the fourth quarter. Garrity expressed concern about a lack of fresh incentives for Google and a growing effort by Yahoo! to focus on small businesses.

On the other side are analysts like Safa Rashtchy of Piper Jaffray who dismiss the notion that search advertising is slowing dramatically. On Tuesday, Lehman Brothers analyst Douglas Anmuth joined the Google bulls with an

upgrade of the stock to overweight from equal weight. Anmuth noted that pricing on search ads is down 3% this quarter, a seasonal decline that is far from a reason to worry. Lehman, which has an investment banking relationship with Google, maintained its $230 price target on the stock, about 24% above its Monday close of $185.29.

"We continue to believe that pricing will not be the largest driver of sponsored search going forward, but rather that query volume, coverage, and click-through rates will prove to be far more important levers," Anmuth wrote. "Google's recent efforts in driving better monetization on its platform have been focused more on improving the relevancy of ads and expanding overall search term coverage. We believe we have seen only the early impact of Google's efforts to improve monetization over the past two quarters."

Garrity at Caris, while pointing out that one quarter of paid-search decline doesn't spell a long-term shift, denoted factors that could keep advertising weak. "We will be dealing with an economy that will be less robust domestically and overseas. Will that lead to a significant decline in online advertising growth? Not necessarily. But advertising is always economically sensitive."

Last Thursday, William Blair & Co. analyst Troy Mastin initiated coverage of Google with an outperform recommendation and an assurance of "significant room for growth" in search. "We would not be surprised if -- for a number of reasons ... growth in U.S.-paid search advertising exceeds 30% in 2005 and 25% in 2006," Mastin wrote. Blair has performed investment banking services with Google.

Mastin also pointed out the possibility that search would evolve to play a more central role in the Internet, putting Google in a position to keep its business growing. "While difficult to predict, search may act as a key 'operating system' for computing for years to come," he wrote. "Google's position as the leader in search may position the company better than any other to capitalize on the opportunities that lie ahead."

The debate is growing because of what remains largely spotty, anecdotal intelligence on what companies are paying for search ads. Google and Yahoo! have a good idea of how their own search ads are doing, but for proprietary reasons they keep quiet until earnings time. Other companies as well as analysts, just rely on their own feedback from advertisers, in essence Wall Street's version of exit polling.

This disagreement is significant, because if analysts are having a hard time coming to a clear consensus, you can bet the big institutional investors are divided on this, too. When the search earnings reports come out -- Yahoo! is slated to report on April 19 and Google the next day -- there's bound to be a bit of extra volatility for what are normally volatile stocks during earnings season.

Google shares closed the regular session up $3.28, or 1.8%, to $188.57; Yahoo! was less affected by the Lehman report, trading up 8 cents, or 0.2%, at $35.15.