NEW YORK (CNN/Money) - Internet company Yahoo! said Monday it plans to buy paid Internet search provider Overture Services Inc. for $1.6 billion in cash and stock.

Susan Decker, CFO of Yahoo!, and Ted Meisel, president and CEO of Overture Services, talk about Yahoo!'s decision to acquire Overture for $1.6 billion. Play video (Real or Windows Media)

Based on Friday's closing prices, the deal values Overture at about $24.41 a share, or a premium of about 13 percent. Shares of Overture (OVER: up $2.58 to $24.09, Research, Estimates) surged about 12 percent Monday afternoon. The acquisition is expected to close in the fourth quarter, according to company executives.

Overture allows advertisers to bid for preferential listing placement in a search engine request and to sponsor keyword searches, having an ad pop up when a certain search term is entered. The company generates revenue based on how many people click on the ads.

Sponsored searches have emerged as one of the hottest trends in Internet advertising since they tend to be more targeted and successful than traditional banner ads. For this reason, several online media companies, including Yahoo!, partner with Overture in order to have Overture's sponsored searches listed on their sites and share some of the revenue.

According to a filing with the Securities and Exchange Commission, Yahoo! said that 19 percent of its total first-quarter revenue came from its sponsored search relationship with Overture. During a conference call Monday, executives from both companies told analysts they believe the growth can come faster if the two companies are combined.

Thanks in large part to its success in sponsored searches, Yahoo! has posted strong sales and earnings results this year, and its stock has been one of the top performers in the S&P 500.

Unlike most Net stocks, Overture has been punished this year due to earnings woes and increased competition.

Shares of Yahoo! (YHOO: up $0.08 to $32.27, Research, Estimates) cooled somewhat last week after the company reported second-quarter results that were in line with, and not ahead of, expectations, causing concerns about the stock's valuation to resurface.

But Wall Street seemed to think the deal was a smart move for Yahoo!. The stock was actually trading slightly higher Monday afternoon. Usually, shares of a company announcing an acquisition fall on the news of a deal.

Steve Weinstein, an analyst with Pacific Crest Securities, said the acquisition would be a major positive for Yahoo! since sponsored searches are becoming an increasingly larger generator of sales for the company, and now Yahoo! will gain complete control of Overture's revenue stream and technology.

The deal also sparked interest in some of Overture's competitors as investors seem to be betting on more consolidation in the search engine area. Shares of LookSmart (LOOK: up $0.83 to $4.18, Research, Estimates) skyrocketed nearly 24 percent on Monday while Ask Jeeves (ASKJ: up $0.68 to $17.10, Research, Estimates) and Findwhat.com (FWHT: up $0.93 to $23.92, Research, Estimates) gained 6.2 percent and 4.2 percent, respectively.

Still, there are some questions about just how big of a business Yahoo! will be inheriting. Overture is expected to post sales of $1 billion this year, an increase of 53 percent from a year ago, according to First Call. However, one of Overture's biggest customers, Microsoft's MSN service, has the option to terminate its agreement with Overture upon change in control of the company.

In its latest quarterly filing, Overture said that revenues generated through sponsored searches on Yahoo! and MSN accounted for 65 percent of its total sales in the first quarter. The company did not give a further breakdown of how big of a customer MSN is, but Mark Zadell, an analyst with Blaylock & Partners, estimates that MSN accounted for about 30 percent of revenue.

So if Microsoft were to bolt, that could mean that Overture would lose about $300 million in potential revenue. Lisa Gurry, a group product manager for MSN, said that Microsoft did not anticipate any immediate changes to its arrangement with Overture as a result of the deal but that the company might evaluate other options for the long term.

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However, Joe Wilcox, an analyst with Jupiter Research, pointed out that Microsoft extended an agreement with search engine infrastructure company Inktomi in February even though Yahoo! acquired that company last December.

In order to lessen its dependence on Yahoo!, Microsoft probably would need to build its own sponsored search service, buy another search engine company or partner with someone else.

"Microsoft is caught between a rock and a hard place. It does not want to be dependent on a major rival but on the other hand, Overture provides a significant amount of MSN's revenue," Wilcox said.

But Overture investors have been clearly worried about increased competition from Microsoft, which has been slowly stepping up its investment in search engine technology, as well as from privately held Google, which has its own sponsored search business called AdWords.

Overture has been one of the few Internet stocks to struggle during this year's explosive Net stock rally. Shares had actually tumbled 21.2 percent year-to-date as of Friday.

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In addition, Overture issued an earnings warning for the year in April. Analysts expect profits to fall 72 percent from a year ago as technology and customer acquisition costs rose. One major problem is that Overture's affiliates are driving a harder bargain and demanding more of the revenue from sponsored searches for themselves.

Although Overture agreed to buy search engine company AltaVista earlier this year in order to diversify its revenue base, rumors that Overture would eventually be bought by Yahoo! have been swirling all year.

"Overture was facing a questionable future. Increasingly what you saw was them giving way more revenue to their partners," said David DuChene, a software analyst with Firsthand Funds, which owns shares of Yahoo!