By Yi-Wyn Yen

These days, getting a large handout from venture capitalists is rare. It’s even tougher when your startup needs a lot of cash to compete with Google.

Kosmix, however, has defied the odds. In late October, the plucky startup raised $20 million, led by Fortune’s parent company Time Warner (TWX), by assuring investors that Google is not the only way to search on the Web. Kosmix says it takes a new approach to searching by categorizing everything by broad topics for those times when you don’t know exactly what you’re looking for.

“This reflects the fact that Kosmix has a unique technology that’s working well,” said Jonathan Miller, the former chief executive of AOL who is on Kosmix’s board. “No question it’s a difficult period to raise significant amounts of money in a late-stage round.”

A powerhouse of investors are banking on a future where search will evolve beyond typing in specific keyword terms on Google. Former Motorola CEO Ed Zander, who launched the popular Razr mobile phone, recently joined as a private investor and advisor to the company. The Mountain View-based startup, which has raised a total of $55 million in three years, is also backed by Amazon (AMZN) cofounder Jeff Bezos and Legg Mason fund manager Bill Miller.

Miller recently made noise for reportedly raising money from private investors to buy Yahoo (YHOO). Miller, a one-time Yahoo board nominee, refused to talk about Yahoo. He discussed the need for companies like Kosmix to take search to a new level in a way that Google (GOOG) does not. As CEO at AOL, Miller had tried to acquire Kosmix, cofounded by veteran entrepreneurs Venky Harinarayan and Anand Rajaraman. “How do you create breadth and depth in content pages and make it a satisfying user experience is a big and hard problem,” Miller said. “Kosmix has firmly established the lead in how this is going to happen.”

Take the phrase Mount Everest as a topic. Without more search keywords, Google broadly targets what you may be looking for. Google’s first three links include an empty graphics box from Google Maps, a Wikipedia entry, and a well-regarded news site for mountain climbers. The same topic on Kosmix returns a rich summary from Web 2.0 sources. Kosmix includes a short paragraph from Wikipedia along with photos from Flickr, videos from YouTube and video search engine Truveo, forum posts from trekkers seeking climbing partners to Everest, and top mountaineers who’ve climbed Everest.

Rajaraman insists his startup is not another search engine trying to take on the search giant. Google’s competitors – from tiny startup Cuil to software maven Microsoft (MSFT) – are struggling to make a dent in Google’s growing dominance in search despite spending billions. The approach, Rajaraman says, is to deliver relevant results with blogs, videos, pictures and news on a single page.

“We consider ourselves an explore engine. When you don’t know what’s interesting or know enough about a topic, you come to us. We’ve built algorithms based on topics that lead to a very different end point,” he said. “Google’s algorithms are about finding the best Web pages out there. It’s really, really hard to mess with that.”

By Scott Moritz

With clouds of economic gloom darkening the tech horizon, mobile phone sales – a former bright spot in the gadget world – look to be slowing.

Tech buyers went away early this fall, and as recession fears intensified, orders have continued to dry up.

There have been a number of ominous signs. First Cisco (CSCO) slashed its outlook and froze hiring. Then Wall Street analysts slashed Google’s (GOOG) search ad sales estimates, predicting the first ever drop off in the company’s growth rate.

Now, market analysts at Gartner have peered ahead into future and declared cell phone sales will likely slow from 2008 levels by 1% to 4%. This would be the first year-over-year slowdown since 2001.

“It is too early to say how long the economic climate will impact the devices market, but we expect market conditions to remain challenging through at least the first half of 2009,” Gartner analyst Carolina Milanesi said in a statement Tuesday.

A low single digit drop in sales certainly isn’t a steep fall and hardly a surprise in light of recent downward adjustments from wireless phone giants Nokia (NOK) and Samsung. But no growth in 2009 would be a major milepost given how newer markets like Brazil, Russia and Asia have been providing plenty of worldwide demand. And in mature markets like Europe and the U.S., smartphone sales are surging, fueled by touchscreens like Apple’s iPhone and Research in Motion’s new BlackBerry Storm.

Gartner now predicts mobile phone sales will hit a growth rate of 8% this year, down from the 15% level in 2007.

By Scott Moritz

It was a tale of two techs Tuesday. Hewlett-Packard (HPQ) surprised Wall Street on Tuesday with a fourth-quarter earnings report that beat analysts’ profit and sales targets. HP shares soared nearly 14% in early trading.

Meanwhile, glass maker Corning (GLW) warned of a sales shortfall in the current quarter as demand for its flat-screen TV and computer panels drops faster than anticipated. Shares fell nearly 12%.

HP posted preliminary adjusted earnings of $1.03 a share, which compares with 84 cents in the year-ago quarter and beats analysts estimates by 3 cents. Sales for the quarter ended Oct. 31 were $33.6 billion, an 19% improvement from revenues of $28.3 billion in the same quarter last year. Analysts were looking for sales of $33 billion, according to Thomson First Call.

The recent acquisition of IT service shop EDS so far has helped HP dodge the full impact of the impending recession. “Our ability to execute in a challenging marketplace differentiates HP, enabling it to increase share, expand earnings and emerge from the current economic environment as a stronger force,” CEO Mark Hurd said in a statement.

Looking ahead, HP predicts pro forma profit of about 94 cents a share on sales of $32.25 billion in the first quarter ending in January. Analysts expected adjusted earnings of 93 cents a share on $33.7 billion in sales. HP says it will release its October quarter earnings Nov. 24.

Corning, however, continues to struggle with order cuts as flat-panels and big-screen TV inventories pile up. The company, the largest maker of liquid crystal display screens for televisions and computers, says fourth-quarter sales will fall below its guidance of $1.1 billion to $1.2 billion. It warned that profits will be at the low end or below its prior guidance of $0.20 to $0.28 a share. Corning did not offer revised financial targets.

By Yi-Wyn Yen

At the Web 2.0 Summit two weeks ago, Yahoo CEO Jerry Yang was asked if he was the right guy to lead the battered Internet portal. Yang dodged the question by defending his passion for the company he co-founded 13 years ago. “I didn’t make the decision of being the CEO lightly,” he said. “I wanted to make a change at Yahoo that I believe I can make….That’s a dream that I felt I could achieve by being CEO and that’s still the dream today.”

That dream came to an end Monday when Yahoo announced that Yang, 40, will step down as CEO and return to his former role as “Chief Yahoo.” The company’s board said it has hired headhunter Heidrick & Struggles to find a replacement.

Yang has come under fire for his inability to turnaround the company in his past 17 months as CEO. During his short tenure, Yahoo (YHOO) has had two major rounds of layoffs and has seen its search market share shrink significantly while a series of reorganizations led to the departure of senior executives. Yang was heavily criticized by Wall Street and shareholders for failing to reach an agreement to sell the company to Microsoft (MSFT). But the final straw for Yang came when Google (GOOG) pulled out of a controversial ad agreement earlier this month that would have boosted Yahoo’s revenues by hundreds of millions of dollars.

“When the board asked me to become CEO and lead the transformation of the company, I did so because it was important to re-envision the business for a different era to drive more effective growth,” said Yang in a statement. “Having set Yahoo! on a new, more open path, the time is right for me to transition the CEO role and our global talent to a new leader. I will continue to focus on global strategy and to do everything I can to help Yahoo realize its full potential and enhance its leading culture of technology and product excellence and innovation.”

When Yang took over, he was widely viewed as the right choice to replace Terry Semel, the previous CEO from Hollywood who spent six years molding Yahoo into a media company. Yang promised change in the first 100 days as CEO, declaring there would be “no sacred cows.” But 100 days came and went. So did the next 400 days. Frustrated investors have seen Yahoo’s shares drop 62% in value since Yang took over in mid-June 2007. While Semel never had Yang’s geek cred, he did manage to drive Yahoo’s stock price up to an eight-year peak of $43.21 in January 2006. Yahoo’s shares closed at $10.63 on Monday.

Yang has admitted his legacy may forever linked to the debacle with the Microsoft takeover. Yahoo’s board and management team quickly turned down Microsoft’s original offer to acquire Yahoo for $31-a-share in February. The two parties spent six months trying to negotiate a deal. “As a CEO, my job is to find the right path for Yahoo,” Yang said at the Web 2.0 conference. Not getting the deal done “is something that I’ll be labeled with.”

By Michal Lev-Ram

SAN JOSE – On the same day that Intel (INTC) slashed more than $1 billion from its sales forecast and more analysts cut sales estimates for Google (GOOG), Silicon Valley luminaries momentarily put the downturn aside and celebrated a happier cause — using technology to benefit the world.

Nearly 1,500 guests on Wednesday night attended the annual Tech Awards, which recognize innovations used to alleviate poverty around the world. ”Tonight is a reminder of all the things that are going right,” said Mike Splinter, CEO of Applied Materials (AMAT), a Tech Awards sponsor. The speech came just hours after the chip equipment maker announced earlier Wednesday that it will cut nearly 2,000 jobs.

The international awards program honored 25 organizations, five of which received a $50,000 cash prize, including Digital StudyHall, an India-based organization that was recognized for bringing instructional DVDs to underpriveledged classrooms.

Other award recipients included the Full Belly Project, a North Carolina-based non-profit that has developed a $50 nut sheller that can shell 125 pounds of peanuts per hour and requires no electricity, which helps subsistence farmers in countries like Mali and Haiti.

The Portable Light Project, another Tech Award recipient, manufactures flexible solar panels that can be woven into clothing or handbags. The wearable photovoltaics harvest sunlight to charge cell phones and other devices. According to the Massachusetts-based nonprofit organization, it is already distributing its portable solar panels in countries like Mexico and South Africa.

“People who are poor are often on the move,” said Sheila Kennedy, who heads up the project. “They don’t have a roof, so you can’t put solar panels up.”

The star of the evening was Muhammad Yunus, who received the Nobel Peace Prize in 2006 for his Grameen Bank, which gives out small loans to some of the world’s poorest people. The father of the so-called microcredit movement spoke about his creative approach to financing and efforts to bring cell phones and solar power to impoverished regions. According to Yunus, his Grameen Bank has doled out more than $700,000 in housing loans (that kind of money won’t get you much in the Silicon Valley, but in Bangladesh a tin-roofed house costs just $300 to build).

Yunus said that when he initially approached banks about lending to the poor, they refused and said poor people are not credit worthy.

“The poor turned out to be more credit worthy,” said Yunus, whose Grameen Bank is self-reliant (it no longer relies on donor funds) and claims to have a loan repayment rate of more than 95% “We never had a subprime housing crisis.”

By Yi-Wyn Yen

Microsoft is trying its luck at social networking – again.

After a failed attempt four years ago, Microsoft (MSFT) is ripping a page from Facebook’s playbook, introducing on Thursday new profile and photo-sharing features to its web-based Windows Live services. The software giant allows users with Windows Live Hotmail or Messenger accounts to create online profiles that highlight what a person is doing through a Facebook-like newsfeed.

Microsoft hopes that giving Windows Live a new facelift will encourage more people to spend more time on its web properties. Checking e-mail or instant messaging accounts for up a third of the time people spend on the Internet, according to research firm comScore. Microsoft has 375 million Hotmail users and 325 million Messenger users worldwide. “If we can gain a whole 60 minutes per user, we would grow a whole Facebook in [time spent],” says Brian Hall, general manager for Windows Live.

Though Hall admits that Microsoft’s new strategy could shift some attention from Facebook – in which Microsoft holds a minor stake – to Windows Live, the real concern is longtime rival, Google (GOOG). The search giant already has a commanding lead in the search advertising business, and Microsoft worries about Gmail’s growing share in the e-mail market. “According to comScore, Google has a 6% share of email [in the U.S.] But they’re growing fast,” Hall said.

Like Google, Microsoft has struggled to make inroads in social networking. Four years ago, Microsoft launched Spaces, a blogging tool to build a social networking site within Windows Live. Though Microsoft added 100 million people in it first year, less than 1% of social networking users use Spaces today. “The blogging approach [to social networking] is not the right approach. People are too busy to make that investment,” Hall said.

Windows Live lets its new newsfeed feature do the heavy lifting to give people’s friends updates on what they’re up to. Microsoft has partnered with more than 50 web companies, including Amazon.com (AMZN), Twitter, Flickr,and iLike, a music discovery site. Anytime you blog on WordPress, write a restaurant review on Yelp, or watch videos on Veoh, your status is updated through your Windows Live profile.

Analysts say the new Windows Live makeover is a preview of Microsoft’s newest operating system, Windows 7. The latest version of Windows is expected to integrate tools like photo-sharing, videos, and messaging more seamless between PCs and mobile devices. “All these built-in applications with a blend of Google, Apple, and Facebook is Microsoft’s view of an integrated world,” said Rob Enderle, president of the Enderle Group. “Windows Live comes out first. This is designed for Windows 7.”

Microsoft’s had success with operating systems, but the company still struggles to make a profit from its Internet businesses. Microsoft is banking that more time spent on Windows Live will translate into more web searches on Live and more ads viewed on its portal, MSN. For its fiscal first quarter, which ended in September, Microsoft lost $480 million from its online unit. “We have to get great at the advertising business,”  Hall said.

By Scott Moritz

What was a little fuzzy last month has become clearer of late: The sagging economy is weighing on Google (GOOG).

Goldman Sachs analyst James Mitchell cited signs of weakness in search advertising – Google’s biggest moneymaker by far — in cutting his revenue growth target for the current fourth quarter from 4% to 1%.

Mitchell is the second analyst this week to lower estimates for Google. On Monday Barclays analyst Doug Anmuth called for fourth-quarter sales to be flat with third quarter’s $4.05 billion. If so, it would be the first time in Google’s history that revenue has not grown from one quarter to the next.

The prospects of little or no growth sent Google shares to a three-year low of $300 Tuesday amid a broad market selloff. The stock has dropped 55% this year. And the news was not particularly good for the rest of the Internet sector with Yahoo (YHOO) dropping 5% to a 52-week low of $11.25.

Why the sudden chill? Google thermometer readers apparently saw a change in tone between the company’s discussions on the earnings call Oct. 16 and the comments in the quarterly filing on Nov.7.

In October, when asked on a conference call how search traffic patterns were going, CEO Eric Schmidt couldn’t draw any conclusions. “We see fluctuations and they are more complex than they may appear; some things go up, some things go down.”

By Friday, when Google filed its 10Q, the complexity had simplified in a not-so-positive way.

“The current general economic downturn will likely affect these seasonal trends, especially the increase in commercial queries that we typically experience in the fourth quarter of each year,” Google said in the filing.

In October, Google executives were partially blinded by the huge increase in search traffic as people swarmed online for news on the financial crisis after Lehman Brothers collapsed Sept. 14. But as search traffic fell back after the initial panic subsided, consumers didn’t revert to their normal behavior and spend their time searching topics like holiday electronics. Ominously for Google, the rate of click-throughs on the sponsored ads that appear to the right of search results also fell, according to some analysts. Marketers pay Google only when someone clicks on their ads.

Goldman’s Mitchell writes that a poor economy is leading to declines in paid search and he noted that the size of purchases at sites like eBay (EBAY) and Amazon (AMZN) are shrinking. Given the lack of pay off, advertisers are likely to resist price increases or even cut spending, according to Mitchell.

In other words: A not-so-happy holidays ahead for the online economy.

By Yi-Wyn Yen

SAN FRANCISCO – In the past ten months, Yahoo CEO Jerry Yang has faced a hostile takeover attempt by Microsoft, shareholder lawsuits, a proxy fight led by Carl Icahn and, on Wednesday, watched a much-needed partnership with Google (GOOG) go up in flames.  Yet the embattled Yahoo chief says he has no regrets that he took on the job.

“I didn’t make the decision of being the CEO lightly,” Yang told a packed crowd of 800 at the Web 2.0 Summit late Wednesday afternoon, hours after Google announced it was pulling out of an ad partnership with Yahoo to avoid a federal antitrust suit.

“I wanted to make a change at Yahoo that I believe I can make,” he said. “That’s a dream that I felt I could achieve by being CEO, and that’s still the dream today. And that’s something that gets lost underneath all these external issues.”

He added, “I don’t regret any minute of it. It might not be the most fun thing, but I feel like I only know how to operate by caring and being passionate about Yahoo.  I just feel that’s the reason that I’m here.”

Yang appeared relaxed while facing tough questions from Web 2.0 impresario John Battelle, who conducted the 45-minute interview at San Francisco’s Palace Hotel. Dressed in a purple-checkered dress shirt, Yang smiled and joked with Battelle who asked him to justify his job and why he rejected Microsoft’s offer to buy the company.

“What happened?” Battelle asked.

“Which part?” Yang said with a smile.

“Thirty-three dollars a share, Jerry. What happened?”

Since Microsoft (MSFT) and Yahoo (YHOO) ended talks in June, Yang has said that the company was willing to sell to Microsoft for the right price. He reiterated his position that he’s still willing to sell the entire company or Yahoo’s search business at the Web 2.0 Summit.

Not convinced, Battelle blamed Yang for failing to get the deal done. “You didn’t want it to happen,” Battelle said.

“I don’t have an ego,” Yang replied. “At the end of the day, we believed the deal was going to be done, and that a deal was not that far apart and they walked away…I know [the failure of the deal] is something that I’ll be labeled with.”

It was the failure of that other deal that seemed to stun Yang. After four months of negotiating with the feds, Google on Wednesday pulled out of a search ad deal that would have generated hundreds of millions of dollars in additional cash flow for Yahoo.

Yang mentioned several times that he was “disappointed” by Google’s decision. “We were working with the Department of Justice to get this deal done,” he said. “We also felt that Google clearly did not want to stay in the deal, and we were disappointed with that.”

Yang had no answer for why Google withdrew. He said, “You’d have to ask them because we are certainly disappointed.”

In a blog post, Google’s chief legal officer David Drummond referred to the deal as too “risky.” The feds threatened to sue Google and Yahoo if they went through with the ad agreement that would allow Yahoo to run some Google search ads on Yahoo’s web properties. The Justice Department believed combining the No. 1 and No. 2 search engines was anticompetitive. Yahoo signaled it was willing to go to court over the deal.

Said Yang, “I really thought the government in this case does not understand this industry. Their thinking is too narrow. I clearly don’t agree with their point of view.”

Yang stressed that the company had “no news” with regards to reviving talks with Microsoft. He also stayed mum on reported talks to buy AOL, which is owned by Fortune’s parent company Time Warner (TWX).

“Are you buying AOL,” Battelle pressed.

Yang laughed and then smiled. “I can’t talk about that. If I tell you, I’d have to kill you.”

Said Battelle, “I think I’ll take the bullet for this audience.”

By Yi-Wyn Yen

The implosion of Yahoo’s ad partnership with Google may or may not lure Microsoft back to bid on Yahoo, but one thing is clear: Making a deal with Yahoo will be a lot less expensive that it was six months ago.

Yahoo (YHOO) is back on the market after Google (GOOG) on Wednesday bailed on the controversial search ad agreement. Investors signaled their approval of the breakup by sending Yahoo’s shares up 5% to $14.02 in mid-day trading.

Microsoft (MSFT) had no comment on the possibility of opening up renegotiations with Yahoo. But the software giant was pleased with the Justice Department’s decision to nix the Google-Yahoo deal, which would have allowed Yahoo to run some of Google’s search ads on its Web properties.

“The Department of Justice’s finding is significant for advertisers, publishers and consumers, who voiced overwhelming concern about this illegal deal to law enforcement and policymakers,” said Brad Smith, Microsoft’s general counsel in a statement.

Microsoft may have won a victory over Google, its bitter rival, but the real loser here is Yahoo. Wrote Jefferies analyst Youssef Squali in a client note, “In our view the GOOG withdrawal is another black eye for [Yahoo CEO] Jerry Yang and Co.”

Analysts say they expect Yahoo’s best option is to go back to Microsoft for a search deal. Summed up Jefferies’ Squali, “YHOO is left with 3 options: 1) go it alone, 2) merge with AOL, or 3) do a deal with Microsoft.”

“Option #1 is not optimal,” he continued, “as shareholders would need to ride out the current recession to get paid. Also having Icahn on the board should make status quo difficult. Option #2 is possible but not to our liking since YHOO would double-down on Display (the weaker segment) with no material benefit to search. Option #3 is the most likely,in our view.”

Google’s ditching of the deal is a humiliating blow for Yahoo. Google announced in a company blog post – a blog post! – that battling the feds in court to save the Yahoo deal was too risky. Three minutes after the Google blog was published, Yahoo released a statement that the company was “disappointed that Google has elected to withdraw from the agreement rather than defend it in court.”

The Justice Department notified Google and Yahoo Wednesday that it would sue both companies if the pair went through with the ad agreement.  Wrote Google’s chief legal officer David Drummond in the blog post, “Pressing ahead risked not only a protracted legal battle but also damage to relationships with valued partners. That wouldn’t have been in the long-term interests of Google or our users.”

Yahoo scrambled to keep the deal afloat. Earlier this week, Yahoo proposed a drastically-scaled version to Google and the government. Yahoo offered to reduce the terms from ten years to two years and only run a quarter of Google’s search ads on Yahoo’s sites.

Analyst Jeffrey Lindsay with Bernstein Research argues that Yahoo was desperate to keep the Google deal going to stay independent. He also says that without the extra cash generated from Google, Yahoo’s attempts to buy Time Warner’s AOL (TWX) business outright is unlikely. Reports have suggested that Time Warner, Fortune’s parent company, would be willing to sell AOL for $6 billion to $8 billion. Lindsay says that at most, Yahoo can only pay between $4 billion to $4.5 billion without diluting its own shares. “Without the Google deal, Yahoo can’t afford to buy AOL,” Lindsay said.

Yahoo brushes off claims that the Google deal is a major loss to the company. Yahoo had originally said that it could make as much as $800 million in annual revenue from the deal. But in its release Wednesday, the company argues that the deal was only “incremental” to its turnaround strategy. “The fundamental building blocks of a stronger Yahoo in both sponsored and algorithmic search were put in place independent of the agreement,” the company said in its statement.

Yahoo struck the search deal with Google four months ago after it ended talks with Microsoft. The move was widely seen as a way for Yahoo to appease shareholders, who were upset that Yahoo turned down Microsoft’s $33-per-share bid. Microsoft had also offered to buy just Yahoo’s search business for a reported $2 billion in June.

Microsoft is still struggling to make a dent with Google’s dominance in paid search advertising. Analysts say that’s all the more reason for Microsoft to come back. “We can’t see why Microsoft wants Yahoo any less than it did nearly a year ago,” Bernstein’s Lindsay said. “All the same reasons still hold true for why Microsoft needs Yahoo. And now they can offer considerably less.”

By Scott Moritz

Yahoo (YHOO) moves back to the deal market as its controversial advertising partnership with Google (GOOG) is now dead.

As Fortune’s Legal Pad blogger Roger Parloff outlined last month, the legal footing was never very solid as the No.1 and No.2 Internet advertisers explored plans to work together on search advertising efforts.

The plan was first introduced in June as Yahoo was trying to fend off an unsolicited takeover bid from Microsoft (MSFT). Yahoo stubbornly resisted Microsoft’s early offers, including a $33-a-share bid in May. Microsoft then walked away and in July, activist investors like Carl Icahn started pushing for a shakeup of the Yahoo board and a more deal-friendly line up.

Yahoo shares, which had fallen to a five-year low of $11.25 last month, surge up 9% on Wednesday after news that the Google partnership was killed.

Investors apparently like Yahoo’s options a lot better without the antitrust battle that seemed to be looming with its Google ad plan. Microsoft and Time Warner’s (TWX) AOL unit – Time Warner is the parent of Fortune and CNNMoney – are among the potential deal partners.

On a conference call with analysts, Time Warner executives said that the news was positive for AOL. “The opportunity remains open for this business to rebuild itself,” the executives said.

By Scott Moritz

Free. That’s Vodafone’s (VOD) recently-unveiled price for the hotly-anticipated touchscreen BlackBerry Storm from Research in Motion (RIM) in the United Kingdom.

In a sign of just how desperate phone companies are to lock customers in to lengthy contracts, Verizon’s (VZ) wireless partner is willing to subsidize the Storm – which sells for about $500 without a calling plan – in order to lure subscribers in England.

Though a final decision has yet to be made, Verizon is considering the same strategy for the Storm’s U.S. debut next month, according to an industry source familiar with the discussions. Another person close to the company says it’s unlikely the Storm will be free.

Verizon declined to comment on its pricing plan for the Storm.

The fact that Verizon is even considering a free phone highlights the competitive pressure created when AT&T (T) started selling a heavily-subsidized Apple (AAPL) iPhone for $199.

Most industry analysts expect the Storm, which has received favorable reviews, to be priced at or below the iPhone.

While Verizon would like to use its exclusive Storm deal to gain an edge in the smartphone market, selling it for free “would be breaking new ground for Verizon,” said Roger Entner, an analyst with Nielsen IAG’s . “It’s likely that they will put it at $150 and maybe $99 if they want to ship massive volumes during the holiday.” At either price, the Storm would be heavily discounted.

Verizon has come up short on blockbuster phones over the past year and a half as the iPhone has become the icon of the smartphone market. AT&T has been a driving force in the U.S. wireless market thanks to the iPhone, which pulls in an average $95 per month. But that drive has also come at a steep price to Ma Bell, which forks over $375 upfront for every iPhone sold. That cost the company $900 million in the third quarter.

For RIM, the Storm represents its biggest step yet into the consumer market as it tries to derail the success of the iPhone. One major challenge is to get devotees of BlackBerry’s physical keyboard to embrace the clickable touchscreen keypad on the Storm. The iPhone’s onscreen keyboard has presented some difficulties for many typists.

So far, Verizon hasn’t had much success with its touchscreen devices. But the Storm, if it’s a hit, could finally establish Verizon as a player in the red-hot touchscreen market. What’s more, it could not only entice new customers, but also convert old lower-paying customers to more expensive contracts. Each Storm subscriber will have to sign up for a BlackBerry e-mail and calling plan, which currently starts at $80 a month.

By Yi-Wyn Yen

Some new bad news for Yahoo. Ten days after the troubled web portal announced it will lay off 1,500 employees, the Wall Street Journal reported Thursday that Yahoo’s deal with Google is on shaky ground.

The Journal said that both Google (GOOG) and Yahoo (YHOO) may walk away from the ad search agreement next week because the Justice Department has been moving toward a suit to block the deal. That would be a big blow to Yahoo, which was banking on making as much as $800 million in annual revenues by outsourcing some search ads on its web properties to Google.

In a statement, Yahoo representative Adam Grossberg said the discussions with the feds are “on going.”

Google representative Adam Kovacevich said in a statement that the company is “continuing to have cooperative discussions with the Department of Justice about this arrangement, and agreed to a brief delay in implementing the agreement while those discussions continue.”

Confidence in the deal is waning. In mid-June, Google and Yahoo originally said they would give the feds 100 days to review the ad pact before moving forward with the agreement. But the pair have faced an uphill battle in Washington. In early August, Yahoo filed a heavily redacted version of the deal to the Securities and Exchange Commission. Then Google CEO Eric Schmidt told reporters that he planned to go ahead with the partnership in mid-October with or without approval from the Justice Department. So far, the feds have yet to give the Internet frenemies the green light.

Critics say the ad pact would give Google too much power and make search advertising less competitive. Google currently owns 62% of the U.S. search market, according to comScore’s monthly figures for September. Yahoo is second with a 20% share and has lost 20% of its search share to Google in the past 18 months.

A source familiar with Google’s thinking said no decision has been made. Some analysts have already moved on even if the feds haven’t.

On Wednesday, J.P. Morgan Internet analyst Imran Khan sent a note to clients on why Yahoo should forget about the Google deal and sell its search business to Microsoft (MSFT). Khan suggests that Yahoo can gain an additional $725 million in operating cash flow from outsourcing search to Microsoft. The software company had offered Yahoo a reported $2 billion to buy its search business after talks to acquire all of Yahoo failed.

Writes Khan, “We think that it is unlikely that the Google/Yahoo search partnership will pass DOJ review in its current form….Without its search business, Yahoo would be very clearly positioned as a content and display advertising entity, thereby clarifying and defining its purpose to advertisers and users.”

By Yi-Wyn Yen

Meet Google 2.0. Gone are the search giant’s free-spending ways – at least for now. The prospect of a severe economic slowdown has forced Google to do something surprising: act fiscally responsible.

The company toned down costly expenses like data centers and new hires and reported profits Thursday of $1.35 billion for the third quarter, up 26% from a year ago. Earnings per share were $4.92, which crushed Street estimates of $4.75 a share.

Google (GOOG) shares rose nearly 11% in after-hours trading to $390. “This is very encouraging to hear that they’re reining in costs and not acting like the drunken sailors that they once were,” said Jefferies analyst Youssef Squali.

The company reported sales of $4.04 billion, a 34% spike from the year-ago quarter, and in line with the Street’s estimates of $4.05 billion.

CEO Eric Schmidt reassured investors that Google’s disciplined outlook would help the company weather an economic downturn. “There’s an awful lot of stuff going on in the world,” he said during an hour-long call with analysts Thursday. “We have a duty and responsibility to run Google well.”

The company scaled back spending on its biggest costs in the third quarter. The company’s capital expenditure for servers and networking equipment was $452 million, its lowest since the first quarter of 2006.

Google also has been trimming general and administrative costs. For the quarter, the company’s expenses grew 28% to $412 million from the same period a year ago. Google, which drew criticism last year for growing too quickly, added 519 employees for the quarter. Last year, the company averaged 1,500 new hires each quarter. “We’ll continue to hire in many areas, but we will do it responsibly,” said Patrick Pichette, Google’s new CFO.

Though many analysts and investors fear that advertisers will sharply scale back on online advertising for the current quarter, Google executives argue that the company could potentially benefit from a recession. Unlike Yahoo (YHOO), which relies heavily on banner-based advertising, Google makes 97% of its revenues from search-based advertising. Google’s chief economist Hal Varian noted that when consumers are “counting their pennies,” they’ll spend more time researching online. More bargain-hunting users will lead to more advertisers, thus creating a “Wal-Mart effect,” according to Varian.

Analysts say they are optimistic about Google’s growth during an uncertain economy. The number of clicks for Google’s paid search ads on third-party sites rose 18% in the third quarter from the same period a year ago. Said Squali: “They don’t seem to be experiencing the weakness you see with a lot of other online players.”

By Scott Moritz

With touchscreen phones all the rage, and U.S. telcos following AT&T’s (T) lead of cutting the price of Apple’s (AAPL) iPhone, it would seem Nokia (NOK) will be left out of the smartphone party this year.

The Finnish phone giant won’t have its closely-watched 5800 phone – Nokia’s music-loaded take on the iPhone – available here until sometime in the first half of next year, according to people familiar with the phone. Nokia wasn’t immediately available for comment.

And even when it arrives, Nokia has lacked a big U.S. phone partner that would provide the subsidy necessary to put it under the $200 range. At full price, it will have a hard time making a big splash.

“You could look at it as having a 100% upside,” says Nielson IAG analyst Roger Entner, referring to Nokia’s measly share of the U.S. market. Make that a potential upside of 95.5% since Nokia’s slice of the U.S. market has now fallen a percentage point from year-ago levels to 4.5%.

These numbers were part of Nokia’s overall solid third-quarter performance reported Thursday. Nokia posted an adjusted profit of 44 cents a share, down from the 55 cents it netted last year, but in line with analysts estimates. Sales fell 5% to $16.4 billion from $17.3 billion in the year-ago quarter and below the $17.2 billion street estimate.

After hitting a new four-year low, Nokia shares rebounded a bit Thursday up 4% as investors took some confidence from the fact that it met estimates.

As Nokia predicted, its worldwide market share fell to 38% in the third quarter from 40% in the prior period. The decline, according to Nokia, reflects the company’s unwillingness to cut phone prices amid a heated price war in some regions.

Nokia has managed to grab and hold onto the No.1 phone supplier position by honing its skills at making low- and medium-priced phones for a global audience. This focus on the mainstream has caused Nokia to be consistently late to fashion trends like flip phones, ultrathin designs and now touchscreens.

After a strong start in the smartphone wars with over half the global market in 2007, Nokia has dropped to a 35% slice in the third quarter from 48% of the market in the second quarter, according to Morgan Stanley analyst Jim Dawson. The alarming sequential drop is a reflection of how strong rivals like Apple and Research in Motion (RIMM) have grown. The smartphone market will get a new challenger later this month with the arrival of Google’s (GOOG) Android-powered G1 phone at T-Mobile.

But while 2008 is not going to be a big year here for Nokia, the trends – aside from the slumping global economy – are promising overall.

Each player comes from with a different specialty to the smartphone market, says Entner. Apple and Google aim for a strong Internet experience and RIM’s BlackBerry Storm hopes to capitalizes on its successful e-mail background with a touchscreen design. “Nokia comes from a mobile phone approach,” says Entner.

“Nokia sees the phone as an integrated device.” says Entner. In the past three years, Nokia has acquired mobile e-mail shop Intellisync, GPS mapper Navteq and digital media delivery system Loudeye in an effort to control the delivery of services like e-mail, navigation, photography, music, videos, games and the Internet. 

Of course, all this will matter more in the U.S. when Nokia can deliver the device.

By Scott Moritz

Recessions are supposed to be boom times for yard sales and flea markets, so what’s eating eBay (EBAY), the world’s largest bargain bazaar?

Ebay shares hit a new five-year low Thursday as yet another analyst weighed in on the nagging deterioration of the auction giant’s business. Morgan Stanley analyst David Joseph downgraded eBay to neutral, pointing out that there are some troubling trends contributing to the company’s drooping e-commerce market share.

With fears that the credit crisis could throw the economy into a tailspin, Wall Street has been in a bit of a selling mood of late. When analysts point to signs of strain at eBay, investors don’t seem inclined to wait and see.

Foremost among eBay’s challenges, Joseph writes, is buyers’ shifting preference in favor of easy shopping, and away from the auction format. People like features like free delivery, shopping various selections within categories, and conveniences like one-click checkout. As the go-between agent in a transaction, eBay has limited control over these features.

As the analyst notes: Ebay is at a disadvantage in its “ability to compete in buyer experience.”

Given the changing tastes among shoppers, it’s not too surprising that eBay’s market share has dropped to 17% from 19% in the past two years. It’s also not shocking that Amazon’s slice of the business has grown to 5.3% from 3.7% in the same period, according to Morgan Stanley.

Other competitors have edged in as well. Local online swap shop specialist Craiglists has its fans. And while far from a runaway success, net giant Google’s (GOOG) Google Checkout purchasing system is an alternative to eBay’s PayPal service.

The weakening economy is having an impact on eBay also. Analysts point out that people are buying fewer items and at lower prices. So with less big ticket sales to add to the total tally, the overall average selling price is falling. And with the slowing sales volume in September, particularly in the U.S., eBay’s growth rate is “under pressure,” according to a Merrill Lynch report Tuesday.

To be sure, eBay has a solid position globally as the marketplace where sellers of cheap goods meet hunters of good bargains. And as a company, eBay is an upstanding financial citizen, with zero debt, $3.7 billion cash in hand, and a cash flow generation rate of $3 billion annually.

But as we saw this week with Monday’s 9% drop in the Nasdaq, even solid favorites in tech like Google, Apple (AAPL) and Research in Motion (RIMM) get trampled when people stampede for the exits.

Worries about eBay’s slowing growth and shifting consumer preferences certainly don’t encourage the highest bids in a market prone to panic.

By Yi-Wyn Yen

How desperate is Microsoft to compete with Google in search? The software behemoth is now giving away prizes every time you use its Live Search engine.

Microsoft (MSFT) launched the rewards promotion called SearchPerks on Wednesday to lure Internet users away from Google. SearchPerks, which runs through April 15, is similar to airlines’ frequent flyer programs. Every time you use Live Search you earn points that can be redeemed for prizes like ringtones, Xbox games, and t-shirts.

Rewarding consumers to search is one way Microsoft hopes it can increase search traffic. The company ran tests on SearchPerks and found that people were three times more likely to use Live Search when they were offered redeemable points than when they weren’t. “People like to engage with us a lot more when they use SearchPerks,” says Frederick Savoye, a senior director on Microsoft’s search team.

Google (GOOG) holds 63% of the U.S. market. Yahoo (YHOO) is second with 19% and Microsoft’s Live Search is a distant third with an 8% share, according to comScore’s figures for August.

The rewards promotion is an experiment to see if Microsoft can build loyalty with Internet users. SearchPerks is limited to the first 250,000 users in the United States that download a web application that records how many searches they do daily on Google, Yahoo or Microsoft.

Savoye says to maintain privacy the widget only tracks the number of searches and not the type of searches people do. SearchPerk users get one “ticket” for every search done on Microsoft, and can receive up to 25 tickets a day.

On April 15, SearchPerk users can cash their tickets for prizes. Microsoft has not yet determined how many points you need to claim the freebies. (However, another Microsoft rewards program, Live Search Club, shows that 105 tickets equals a free downloadable song and 1,000 tickets are needed for 500 frequent flyer miles.)

The program is currently available on Internet Explorer 6 or higher. Savoye says engineers are also developing a version for the Firefox browser.

SearchPerks follows Microsoft’s launch in May of the cashback program that pays consumers when they buy products through Live Search. Savoye says SearchPerks is another piece of Microsoft’s plan to “innovate the [search] business model.”

However, the company’s efforts to build search market share is steadily declining. Microsoft Live Search’s share has dropped 1.5% since the start of the year.

Wrote Collins Stewart Internet analyst Sandeep Aggarwal in a note to clients Tuesday: “Internal initiatives at MSFT need time to lift off and prove their merit, but sooner or later the company will have to face the realities and decide again if a combination with YHOO can speed the process.”

By Scott Moritz

Three of tech investors’ favorite horses - Google (GOOG), Research in Motion (RIMM) and Apple (AAPL) - which led the stampede out of the Nasdaq Monday, came rushing back a bit Tuesday.

Panic sellers who sent the Nasdaq down 9%, its steepest one-day drop since the Internet bubble burst in 2000, were replaced by bargain hunters Tuesday. In mid-day trading Google shares were up 8% and RIM’s stock bounced 10%. Apple was up 5%, while the Nasdaq as a whole rose 3%.

Apple was one of the biggest losers Monday, falling18% after two analysts downgraded the stock on fears that Mac sales were going the way of the rest of the PC market. FORTUNE’s Philip Elmer-Dewitt, however, pointed out that some of the gloomy predictions were based on a survey of business IT buyers, not quite Apple’s core market.

Other analysts came to Apple’s defense Tuesday. Goldman Sachs’ David Bailey reiterated his buy rating  saying the stock was oversold.

“We think yesterday’s 18% decline more than captures the concerns over Mac growth in a weakening spending environment, making Apple shares attractive at current levels,” Bailey wrote.

Monday’s broad selloff, and in particular the Nasdaq’s plunge, kicked into high gear after lawmakers failed to pass a Wall Street bailout bill. Amid fears that the current credit crunch could push the economy into a deep recession, not even the tech sector’s lack of debt and strong cash position were enough to keep panicky investors from bailing.

Tuesday’s rebound offered some solace, but as Monday’s collapse showed, tech is along for Wall Street’s ride, like it or not.

By Scott Moritz

Apple (AAPL) got hit with a pair of downgrades Monday as analysts see a weaker consumer taking a big bite out of the computer-maker’s growth rate.

RBC and Morgan Stanley analysts slapped Apple with neutral ratings, down from buy, on concerns that the slumping economy will put a chill on sales of Mac notebooks and desktop computers.

Citing a IQ/Changewave survey, RBC noted that 40% of consumers questioned said they “plan on spending less on electronics in the next 90 days,” RBC analyst Mike Abramsky wrote in the note. This is the weakest outlook ever measured in these surveys, Abramsky wrote.

Apple shares fell 16% in morning trading Monday in the wake of the reports, as investors get a sobering view of how popular consumer devices can lose momentum in a faltering economy.

The growing credit crisis has helped deflate consumer confidence and force delays in purchases of items like new computers and flat-screen TVs. The problem for Apple, writes Kathryn Huberty in a downgrade of Apple to neutral Monday, is that not only is PC sales growth slowing but the one area shrinking less is the under-$1,000 price range where Apple is absent.

Add the slowdown in PC sales to the higher costs of iPhone production, and Huberty says there will be a dramatic drop in Apple’s profit growth. Huberty cut her Apple earnings growth projection for the year to 6%, well below the 9% analysts’ consensus average.

Apple is not recession proof, RBC’s Abramsky writes.

Not surprisingly, investors have taken flight from stocks in some of the stronger players as the market jitters spread across nearly all sectors. Apple shares are down 35% and smartphone rival Research in Motion (RIMM) is down 47% in the past month.

RIM’s disappointing outlook Thursday confirmed that the once hot smartphone segment is cooling just as the larger mobile phone market grinds into slow gear, not just in the U.S., but globally as Nokia (NOK) recently pointed out.

By Yi-Wyn Yen

The Google-Yahoo search advertising pact will get approval from the Department of Justice in the next few weeks, but not without some serious scaling back of the deal, according to one analyst.

Thomas Weisel Partners managing director Christa Quarles expects the Justice Department to put limits on how often Yahoo will be allowed to run Google’s (GOOG) ads on Yahoo’s web properties. Yahoo’s revenue-sharing agreement gives the Internet portal flexibility on the number and the type of Google ads it can show. Quarles predicts that the Justice Department will not trust Yahoo enough to give it that much freedom.

“The DOJ will put some caps on how much Yahoo can move over to Google,” Quarles says in an interview.

Google and Yahoo (YHOO) plan to start the partnership in October. The pair gave the Justice Department 3.5 months to review the agreement for antitrust concerns after striking a deal on June 12. Any restrictions on the deal that the government wanted could either be accepted by the companies or not, in which case the feds would have to decide whether to pursue court action. The department has reportedly hired Sanford Litvak, a top litigator, to head up any case.

The agreement the companies struck allows Yahoo to use Google’s technology to display Google’s ads alongside Yahoo’s search results. The search giant will pay Yahoo a portion of the revenues it gets over four years. Yahoo will have the option to renew the deal in two straight three-year terms. Industry analysts estimate Google gives its AdSense partners 80% of search revenue, and that Yahoo will get a similar arrangement.

For the month of August, Google controlled 63% of the search traffic in the U.S and Yahoo owned 20%,  according to comScore.

Yahoo is vague about exactly how often it will turn to Google’s search-ad engine to supply results on a Yahoo page. But executives insist they plan to run Google’s ads only when Yahoo has low ad inventory, especially in “long-tail” searches such as “red roses in Birmingham, Ala.”  Yahoo says that the Google partnership can increase annual revenue by $800 million, or 11%.

Quarles argues that the feds will want to put more limits on the deal to keep Yahoo from becoming addicted to Google. “Let’s say Yahoo starts with long-tail queries. Then they start turning up the dial to include the retail segment. And then it’s, ‘Ooh, my. We can double monetization.’ There’s a very high temptation for Yahoo to shift over to Google,” Quarles says.

The ad partnership has received criticism from powerful interest groups such as the Association of National Advertisers and the World Association of Newspapers. Advertisers say they fear the combination of the top two search engines will drive up the prices they pay for search keywords. Newspaper publishers worry that the combined forces of Google and Yahoo will reduce competition and ultimately lead to less revenue and higher fees for them.

Both Google and Yahoo insist that competition will get better as the tarnished Internet portal invests the additional money to improve its search ad system.

Quarles predicts that Yahoo will make far less than the $800 million the company says it can.

That’s not good news for investors who saw a buyout from Microsoft (MSFT) as a better alternative to the Google pact. In a June note to clients, Quarles wrote that Yahoo’s revenue opportunity for the first year will be between $313 million and $563 million. She speculates that Yahoo will outsource no more than 15% of its search ads to Google.

She says now that based on her market research and conversations with Yahoo insiders, the feds will likely limit the agreement in a way that keeps Yahoo’s take to her estimates.