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Yahoo! Runs in Place

Investors welcome a new search engine but don't see much progress against Google.

Updated from 12:26 p.m. EDT

It was hard not to think of the Van Halen oldie

Panama

during

Yahoo!'s

(YHOO)

third-quarter conference call Tuesday. Only it wasn't a fit David Lee Roth belting out the words. And it certainly wasn't Sammy "I Can't Drive 55" Hagar.

Instead it was Yahoo! CEO Terry Semel, for whom 55 has been a bit of a challenge this year, given the number of speed bumps his Internet company has been hitting.

In fact,

Panama

is emblematic of the slow, painful turnaround for Yahoo! to reinvigorate itself into an Internet leader whose ad revenues are again growing faster than the industry at large.

To his credit, Semel was frank about Yahoo!'s disappointing performance and vowed to fix things. "We are not exploiting our considerable strengths as well as we should be," he told analysts. "Near-term, we are expecting our growth to be in line with the overall market. ... That is not where we should be."

Panama, the new search technology that would in essence Google-ize Yahoo's search engine, is supposed to help change that.

Yahoo!'s searches had long relied on Overture technology, which ranks search results according to the amount advertisers pay for keywords.

Google's

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search algorithms had also done this, but they also ranked results according to relevance. Panama was Yahoo!'s way of catching up, in a broad sense, with Google.

But Panama was plagued by delays. It was originally slated to be rolled outlast summer, but Yahoo! announced that it wouldn't be ready until the first quarter of 2007. Given Google's steady habit of growing market share, while Yahoo!'s stood still or even eroded, the market didn't take that news too well.

But in Tuesday's the conference call, Semel said Panama had been launched that very day. "Starting today, we have begun inviting advertisers in the U.S. to upgrade to the new campaign management application," Semel said. "In fact, we even had our first external customer transition to the platform today as well."

As analysts drilled down, it became clear that the financial impact of the new engine would not be immediate. Asked when the new ranking algorithm would be put to use, Semel acknowledged it would happen nextquarter as scheduled, and CFO Susan Decker said "we would not expect a financial impact for at least a quarter after that."

"We would begin to see a financial impact we believe in Q2, and that would build over time as the system and machine learns, and also as we roll out to other international countries later in 2007," Decker said.

Panama! Panam-ah-ah-a!

Between the lines, of course, was the unspoken reality that if it takes you a couple of years to catch up to your chief rival in terms of search technology, your rival has had a couple of years to race that much further ahead of you. Google is famously mum about its own algorithms, but the bulk of its growing corps of engineers has been focused on sharpening its search engine.

Yahoo!'s stock seesawed after the announcement as initial optimism about the Panama news drove the stock up 5% in after-hours trading Tuesday. After a brief pop Wednesday, Yahoo! closed at $22.99, down nearly 5%.

Elsewhere in Yahoo!'s report, there was little to celebrate. The company guided third-quarter revenue between $1.12 billion to $1.23 billion, then last month it warned that revenue would come in at the bottom half of that range. It turns out it was at the rock-bottom of that range, with revenue, excluding what it pays search partners, at $1.12 billion.

Net profit came in at $159 million, or 11 cents a share, for the quarter ended Sept. 30, down from the year-ago $254 million, or 17 cents a share.

Yahoo! underscored the severity of the slowdown by cutting guidance for 2006. It said net revenue would come in between $4.48 billion and $4.60 billion, down from its previous guidance of $4.6 billion to $4.85 billion. The company said operating income would be between $866 million and $906 million, down from the previous range of $935 million -$1.03 billion.

In other words, the fourth quarter will continue to be grim. Analyst Imran Khan of J.P Morgan estimated that Yahoo!'s gross search revenue grew by 15% last quarter, down from 25% in the previous quarter and down from 53% a year ago. Growth in the fourth quarter is expected to slow to 5%.

Part of the slowdown was caused by the loss of

Microsoft's

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MSN as a search partner. But Khan cited other factors, including eroding market share, especially in Europe, and lower bids from advertisers "due to dissatisfaction with the ROI dynamics at Yahoo! when compared to Google and MSN."

For Yahoo! bulls, this may mark the turning point of the hard times the company has faced this year. Panama could revive Yahoo!'s revenue in a few ways -- helping it steal market share from smaller players, preventing big advertisers it has long worked with from defecting to Google, and offering it a platform to add new innovations that could give it an edge in the long run.

"I feel very, very good about our capabilities and the people behind the steering wheel," said Semel. But for the next few quarters, at least, the road that Yahoo! is driving on will be an uphill one.