Sunnyvale, California: Carol A. Bartz, chief executive of Yahoo Inc., has been hobbled.

Three weeks ago, doctors gave her a new left knee, made of titanium and plastic. As a result, she is limping around Yahoo’s headquarters here, occasionally standing to hold a chair and stretch her leg while a bottle of painkiller Percocet sits at the ready on her desk.

Losing sheen?Microsoft chief Steven A. Ballmer (right) and his counterpart at Yahoo, Carol Bartz, sign an agreement for partnership in Internet search and advertising at Yahoo headquarters in Sunnyvale. Yahoo Via NYT

In a lengthy interview on Friday before departing for a vacation, Bartz said she sold the search business because Yahoo could no longer continue to match the level of investment Google Inc. and Microsoft were making in searching, one of the Web’s most lucrative and technologically complex businesses.

While reducing the marketing and infrastructure costs associated with search, the deal will also provide money that Yahoo can use to bolster other businesses. Bartz plans to invest the money in Yahoo’s display ad, content and mobile services technology.

Yahoo will lose some of its most talented engineers to Microsoft and as many as 400 employees through layoffs. The deal also undercuts years of investment around search technology. By selling the technological crown jewels, the company also may lose some of its high-technology credibility.

But the core of Yahoo remains intact, according to Bartz. “We haven’t eviscerated the company," she said.

Given Yahoo’s battering by investors, Bartz lamented that Yahoo and Microsoft failed to explain the relationship better to Wall Street. She blamed herself for a comment she made several weeks ago, at an industry conference, that Microsoft would have to pay Yahoo “boatloads of cash" to win its search business.

Wall Street had become enamoured with the previous, more immediately lucrative proposals between Microsoft and Yahoo. Last year, in an attempt to improve its search business and better compete with its archrival Google, Microsoft offered $46 billion (Rs2.2 trillion) to buy all of Yahoo. Analysts estimate that the new deal—involving what many people saw as Yahoo’s most important asset—is worth only around $4-5 billion.

“It’s rather like getting a Picasso and saying, ‘You know, the canvas costs $200, the paint cost $300, so we’ll sell it to you for $500’," said Jeffrey Lindsay, an analyst at Sanford C. Bernstein. “I’ve never seen investors so angry."

Microsoft chief Steven A. Ballmer has gone to unusual lengths to defend the deal on Yahoo’s behalf. Last week, he told a group of investors gathered at Microsoft’s headquarters that it was “sort of unbelievable" that Yahoo got to keep such a high percentage of the ad sales while spending nothing on the underlying infrastructure to run the search operation.

And Bartz argues that the more generous offers came during far different economic times. In addition, she said, analysts have underestimated the two-and-half years it will take to integrate the two companies’ search and advertising systems. The companies also face the daunting process of getting approval from regulatory agencies that are now closely scrutinizing deals on antitrust grounds.

Bartz said that she avoided Ballmer’s immediate advances after taking the helm of Yahoo. “He called my first day," she said. “I told him: ‘Go away. I haven’t even found the bathroom.’"

When Bartz finally began negotiations, Ballmer presented two options: a large up-front payment or a higher percentage of revenue tied to ads sold on Yahoo websites.

Ultimately, Ballmer and Bartz ended up on the phone debating minute details. Bartz also fought to play down Microsoft’s Bing brand on the Yahoo search results page, with just a bit of text instead of a logo, and she pushed Ballmer hard to make sure that Yahoo retained the right to sell its own display ads to big advertisers.

Meanwhile, Bartz has plenty of other work to do at Yahoo. She has picked up on the dysfunction throughout the company during her eight months on the job.

For one, Yahoo has not poured enough money into creating a top-class technology infrastructure capable of delivering a variety of services to consumers.

Bartz also complained about a lack of balance between the different product groups. Motivated employees in the company’s sports section have turned it into a must-visit Web destination by breaking news stories and providing witty commentary. Other sections have languished.

Spending money to fix these problems made more sense to Bartz than haemorrhaging cash in a bid to keep pace with Google and Microsoft.

Microsoft has backed its new search engine Bing with billions of dollars in infrastructure and marketing investments. While encouraged by some of Bing’s innovations, Bartz figures that Google will most likely match them soon. “That is the arms race I don’t want to be in," she said.

But some investors fear that Yahoo may be trading the most profitable business of the 21st century—search—for a deflating, hyper-competitive media business that appeared to peak in the 20th century.

“I don’t think the surviving pieces are very interesting," said Michael Lippert, manager of the Baron iOpportunity fund, which acquired Yahoo shares earlier this year on the anticipation of a lucrative search partnership. Lippert was disappointed by the terms of the deal but did not make out too badly; his fund also owns Microsoft stock, which rose slightly last week. “Ballmer got himself a fantastic deal."

©2009/The New York Times