Yahoo (YHOO)

Founded by David Filo and Jerry Yang in 1994, Yahoo! Inc. is engaged in the business of serving advertisements across a large number of own and affiliate Internet properties. The Sunnyvale, California-based company's business activities are primarily targeted at the key Internet usage areas of communication, information access, creation and sharing, and online trading.

Services are provided across 30 countries and regions in English and in some cases, also in local languages. The sales effort in the U.S. is split between a direct sales force online services that enable advertisers to directly place text-based links to their websites on Yahoo! or affiliate websites and telesales, which primarily targets the small and medium business (SMB) category. Sales activity in international markets is either carried out by the company itself or through local agencies.

The primary competitors are Google, Microsoft and Time Warner's America Online (AOL).

In 2009, the company generated nearly 88% of revenue from marketing services, which was a decline of 1.0% from 2008 levels. The remaining 12% came from fees. Within marketing services, owned and operated sites accounted for 55% of total revenue, while affiliate sites contributed 33%.

Around 73% of 2009 revenue was generated within the U.S., while the balance came from international markets.

REASONS TO BUY

New management has taken steps to beef up the mail, search and social networking businesses, which have traditionally been Yahoo's strengths. In order to remove management distractions and increase focus on these core businesses, management has decided to dispose off non-core assets. To this end, the 39% stake in China's largest ecommerce company, Alibaba.com was sold for $150 million. Yahoo HotJobs was sold to Monster.com in February 2010 and the Zimbra e-mail service to VMWare later in the year. However, management failed to get a suitable offer for the Small Business assets and have therefore shelved the decision to sell it off. The small business division provides domains, email, web hosting and other merchant services to customers. While the sale of some of these assets may not generate net gains, they are in line with the company's strategy of disposing off or shutting down assets that are not key to its current strategy.

In the past, the company has made a large number of acquisitions, which have helped it grow a well-diversified business. With the recent change in philosophy, management is now looking at acquisition of targets that could help it augment its new business focus. The most significant acquisition in 2009 was that of Maktoob. However, the company also made a number of smaller acquisitions, such as the U.S.-based start-up company, Xoopit for $20 million. Xoopit brought technology facilitating the sharing of content from in-boxes with social-networking sites and the company's specialization in mail applications, indexing and content discovery was expected to enrich the Yahoo! mail experience. The largest acquisition in 2008 was Maven and the largest acquisitions in 2007 were Right Media, Zimbra and Blue Lithium. Recently, the company bought Associated Content, which will help it deliver ads to an even larger audience.

The company has been strengthening its position in the under-penetrated but fast-growing Arabic countries. The acquisition of Dubai-based Maktoob.com, the world's first free Arabic/English Web-based email service, is in furtherance of this growth initiative. The acquisition will allow the company to combine the Yahoo! experience with Maktoob's Arabic language, content, programming and services. Maktoob has grown into the leading online Arab community with more than 16.5 million unique users across Jordan, Kuwait, Egypt and Saudi Arabia. The World Bank estimates that there are 320 million Arab speakers around the world, so there is significant growth potential. Online advertising in the region is expected to grow 35-40% this year, according to Madar Research and a recent survey by the International Quality and Productivity Centre showed that 73% of 1,048 respondents intended to focus their online advertising efforts in the region. However, the primary challenge is the service of meaningful advertisements to an Arab community, which we expect Yahoo will address very soon.

In March 2010, the company signed a deal with Nokia Corp that is expected to enhance its position in the Asia/Pacific region. The agreement was an attempt to expand its presence in Asian countries where Nokia phones are the most popular. The rationale behind the deal was to build a position for Yahoo in those Asian markets where it had low penetration. Since a Nokia phone is more or less a household item, the addition of Yahoo email and chat features here would generate significant publicity for the company. Yahoo would also be in a position to take advantage of Nokia's advanced mapping services, an area where it hugely lags arch rival Google. Management has also acquired Koprol, a small Indonesian company with the ability to provide local information on cell phones. The company intends to use this technology for expansion within Indonesia, as well as other Asian countries. The company recently started breaking out Asia/Pacific and EMEA regions separately and it is now evident that the Asia/pacific business grew 38.5% to 20% of total revenue from 15% of revenue in the year-ago quarter. In fact, Asia was the only region that saw year-over-year growth in the last quarter.

Management has also taken steps to make the search business more profitable. It recently announced a ten-year agreement with Microsoft that should be beneficial for both parties. Regulators in both the U.S. and Europe have cleared the deal, according to which Microsoft technology will power Yahoo's search business, enabling it to access important user information. Yahoo will get to collect the advertisements and keep 88% of the revenue thus generated. It is estimated that the company will save around $200 million in search expenses and increase search advertising revenue by $500 million. While the terms are subject to revision a few years down the line, it is obvious that the company has created a cash cow. For the next ten years, the company will be able to innovate in search, build strategy and also utilize resources in other areas, including banner advertisements on its portal and email pages. It will also be in a position to strengthen relationships with advertisers, the source of all revenue and profits.

REASONS TO SELL

Operating performance has not been too good over the past few years. The revenue growth rate has declined from 2006 to 2007 and again, from 2007 to 2008. Last year, revenues were impacted by the recession, so there was another decline. Gross profit dollars also declined in tandem with the lower revenue level. Operating profit dollars declined 24.7% in 2007, 13.4% in 2008 and 14.1% in 2009. We believe 2010 should be a stronger year, with improvement in revenue, gross profit dollars and operating profit dollars. However, the company's initiatives in mobile and video, two areas that are expected to grow very strongly, significantly lag peers. Additionally,

The competition in the online advertising sector is severe and Yahoo's competitors, particularly Google, are very strong. Over the past few years, Google has seen phenomenal growth, not just as a result of market growth, but also at Yahoo's expense. Although the Microsoft-Yahoo deal was intended to challenge Google's position in search and the company had intended to continue its own search business, Yahoo has in fact been losing market share to Microsoft's Bing, even as Google held its own. Google's customer loyalty is very strong and the company remains the undisputed number one choice in search. The display business is also under pressure now, with Facebook emerging as the strongest competitor in the space. Yahoo's stagnation and lack of innovation are likely to result in further market share erosion going forward.

Yahoo has almost no presence in the mobile search market, which is expected to be one of the fastest growing segments within search. The company has no major plans here, other than the deal with Nokia. In contrast Google is taking the market by storm with its Android OS. It has also wrested some share from Yahoo in the mobile and social networking areas. Although Yahoo enjoys a very strong position in the social networking space and the company's renewed effort in the area is encouraging, we believe that it will face stiff competition every step of the way.

Yahoo! has grown into a very large company with sprawling operations. This resulted in many business interests which distracted management and made operation difficult. As a result, the company lost ground in its core search business. Given the fact that technology and customer loyalty are key for growth in this market, the company's position may be hard to reinstate. Although management initiatives could ultimately have a positive impact on performance, especially in emerging markets, such as Asia, it is unlikely to be smooth-sailing for the company. We note that the company was unable to sell off the small business unit for lack of suitable consideration. We continue to have reservations regarding management's ability to bring the company back to its former glory.

There have been a large number of management changes in the recent past. Both the CEO and CFO positions have changed and a board member has stepped down. The VP (marketing technology and strategy) and the head of the connected TV group have also left the company. While some of the changes may be strategic, others are indicative of bad times at Yahoo.

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Company Products/Services/Markets:

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Strategy:

Yahoo readily admits that they have dropped the ball with respect to generating advertising revenue. While Google had a clean, quick, automated process for buying keywords Yahoo subjected all keyword buys to human review. The process was slow and it was common for your keyword requests to be rejected. Even if you succeeded in getting your keywords you would find that you just didn't get that many impressions compared to Google - even after adjusting for the difference in search traffic.

Yahoo's response to this shortcoming was the Panama project which was supposed to better match ads to the underlying searches in order to increase the value of those ads [need discussion of Panama here].

Yahoo was also criticized in October 2006 in an internal memo, known as "The Peanut Butter Manifesto", by Brad Garlinghouse, a Yahoo senior vice president, who called for an overhaul of the company, saying that they had spread their resources too thinly, like peanut butter on a slice of bread.

In an October 16, 2007 conference call Jerry Yang outlined 3 strategic objectives:

1. Become the starting point for the most consumers on the Internet
2. Establish Yahoo! as the must buy for the most advertisers
3. Deliver industry-leading platforms that attract the most developers. They will even be opening up their home page to third party content providers and developers.

Competitors:

Most notably, Google. Also, Windows Live Search (Microsoft) and Ask.com. The table below shows the trends in market share over the last year using data obtained from Hitwise:

While Google has achieved a considerable increase in share over the last year, and some of this has come at Yahoo's expense, the majority of this has come at the expense of the smaller players.

Google and Microsoft are clearly placing more emphasis on display ads, which are Yahoo's strong suit, with Google buying DoubleClick in April for $3.1B and Microsoft buying aQuantive for $6B.

According to Online Media Daily a study conducted by Searchignite and RBC Capital Markets indicated that in Q3 '07 Yahoo's percentage of incremental media spend increased by 7.8% [15].

Industry Trends and News:

It's only a matter of time before the big media buyers wake up to the fact that the Internet provides better bang for the advertising buck than traditional media. According to a November 13, 2007 story in Online Media Daily "big name brand marketers are fed up with traditional media channels and are threatening to shift the lion's share of their budgets online...[because of] a general climate of discontent due to increasing viewer fragmentation, disruptive technologies, and the resulting decrease in ROI. [Clients] are just waiting to increase their online spend to 50% or 60% [of their total budgets]. According to eMarketer projections, Web advertising as a share of total ad spend will reach 7.4% this year, more than 10% by 2009, and at least 13.3% by the end of 2011." [16]

Acquisitions, Divestitures, Major Transactions, Spin-offs :

Yahoo has acquired Right Media ad exchange and the Blue Lithium ad network in an effort to create a "one stop shop" for advertisers. They have also acquired social news service BuzzTracker in an effort to make their user experience more relevant and current. [17]

According to a June 25, 2007 Barron's article there are rumors that Yahoo might be bought by Microsoft or News Corp. "Microsoft and Yahoo! have held informal discussions in the past and News Corp. has been said to be contemplating a swap of its MySpace social networking unit for a 25% stake in Yahoo!" [20] The article goes on to say that Yahoo! Japan is worth $7 B and quotes Larry Haverty of Gabelli Global Multimedia as suggesting that a sale of the entire company could get a price in the upper 30s per share.

Management – Pros & Cons, Changes:

On June 18. 2007 Yahoo announced that Terry Semel resigned as CEO and was being replaced by Yahoo co-founder Jerry Yang. With Terry remaining Chairman and Jerry having been a director of the company during Terry's tenure, and having followed all of Terry's decisions, the obvious question is whether or not anything has really changed.

According to a July 2, 2007 BusinessWeek story the employees are looking for a leader with a tech background who can dismantle the management layers put in place by Semel. It is hoped that this change will reduce employee turnover. [30]

Buy Rationale:

The primary argument for owning Yahoo is that it has an incredible franchise as demonstrated by the graphs above. That franchise clearly has at least as much value as Google but the question is whether or not they can realize that value. If you believe that they can then you should own this stock.

Sell Rationale:

Enter Sell Rationale Here