It has taken over a year and many failed proposals, but Yahoo! (YHOO) and Microsoft (MSFT) announced this morning that they have reached an agreement t0 create a more powerful search engine to compete against dominant Google (GOOG).

The basic concept of the deal is that Microsoft will be the force and power behind Yahoo!’s search engine, using their recently more powerful Bing search engine technology.  Yahoo! will sell the advertising from the new search engine and all search products.

The deal will not include each companies web sites, instant messaging, or email services.

The key terms of the agreement are as follows:

• The term of the agreement is 10 years;
• Microsoft will acquire an exclusive 10 year license to Yahoo!’s core search technologies, and Microsoft will have the ability to integrate Yahoo! search technologies into its existing web search platforms;
• Microsoft’s Bing will be the exclusive algorithmic search and paid search platform for Yahoo! sites. Yahoo! will continue to use its technology and data in other areas of its business such as enhancing display advertising technology.
• Yahoo! will become the exclusive worldwide relationship sales force for both companies’ premium search advertisers. Self-serve advertising for both companies will be fulfilled by Microsoft’s AdCenter platform, and prices for all search ads will continue to be set by AdCenter’s automated auction process.
• Each company will maintain its own separate display advertising business and sales force.
• Yahoo! will innovate and “own” the user experience on Yahoo! properties, including the user experience for search, even though it will be powered by Microsoft technology.
• Microsoft will compensate Yahoo! through a revenue sharing agreement on traffic generated on Yahoo!’s network of both owned and operated (O&O) and affiliate sites.
• Microsoft will pay traffic acquisition costs (TAC) to Yahoo! at an initial rate of 88% of search revenue generated on Yahoo!’s O&O sites during the first 5 years of the agreement.
• Yahoo! will continue to syndicate its existing search affiliate partnerships.
• Microsoft will guarantee Yahoo!’s O&O revenue per search (RPS) in each country for the first 18 months following initial implementation in that country.
• At full implementation (expected to occur within 24 months following regulatory approval), Yahoo! estimates, based on current levels of revenue and current operating expenses, that this agreement will provide a benefit to annual GAAP operating income of approximately $500 million and capital expenditure savings of approximately $200 million. Yahoo! also estimates that this agreement will provide a benefit to annual operating cash flow of approximately $275 million.
• The agreement protects consumer privacy by limiting the data shared between the companies to the minimum necessary to operate and improve the combined search platform, and restricts the use of search data shared between the companies. The agreement maintains the industry-leading privacy practices that each company follows today.

Rumors of the deal had helped shares of Yahoo! rise over the past month from around $10/share up to $17.22 this morning before the markets opened.  Shares of Microsoft were at $23.47.

Yahoo! turned down an offer from Microsoft about a year ago to purchase the internet search pioneer for $33/share.  Naturally, the CEO and founder of the company Jerry Yang, has since been replaced by Carol Bartz.

Yang viewed the company as his baby and had a hard time letting it go for $33 a share, much to the outrage of shareholders.  The market crashed and shares dropped from $33 down to $8.94

Bartz has been determined to not sell the company but to find a way to reach a mutual benefiting deal with Microsoft.

The great reviews and early success of MS search engine Bing, combined with Yahoo!, might be just enough to not beat Google, but at least give them some decent competition for search traffic and dollars.