Yahoo! (YHOO)

Nearly all of Yahoo’s revenue comes from search and display advertising. Yahoo has been losing share in search; Google’s superior algorithms boosted its share into the mid sixties. In the English lexicon, Google has become a verb “Google xyz,” meaning to perform an internet search. Yahoo is still the second most popular search engine, but I believe most Yahoo searches are secondary events.

Yahoo’s content attracts users, who in the course of their visit, become compelled to search for a particular item and do so on Yahoo, instead of navigating to Google. Conversely, users not on Yahoo’s portal choose to navigate to Google as opposed to Yahoo to perform a search query. Hence, some of Yahoo’s search traffic is a matter of circumstance, and not necessarily one’s usually first search engine choice. Therefore, the content from the portal aids in generating search traffic, but without a superior search engine, search depends heavily on traffic the portal attracts.

53% of Yahoo’s revenues come from advertising on its own properties, and segment revenues increases 18% in Q1. Yahoo attracts traffic through its news, finance, sports, and mail content/services. There isn’t anything proprietary about the content Yahoo provides, thus can be duplicated. In addition, Yahoo is buggy. Yahoo Mail doesn’t work right (search & spam filter), sometimes pages don’t render correctly and tables fail to populate. Groups and message boards are filled with spammers.

If we follow Yahoo's fundamentals and compare its financial performance with companies with similar P/E ratios, we would value Yahoo at about 15 dollars a share. Because Microsoft's stock has declined, the value of its offer (which included a stock component) has upset the yahoo board, which feels that it can fetch a higher price. The current 27 dollar price is very volatile and will be subject to enormous fluctuations based on any update in the merger talks. Rationally, this deal should be the best option for shareholders of Yahoo!, because the firm has no realistic target of regaining its share value to 27 dollars any other way.

Yahoo Inc (NASDAQ:YHOO), the world’s second largest search engine, has been a relatively flat stock since 2005. Only recently since a formal proposal for takeover from software giant Microsoft Inc. (NASDAQ:MSFT) has the stock seen a boost in price.

What many investors fail to realize is that the best-case scenario is already priced into the stock. As Yahoo!’s current pace, the stock price would be set to wither away like a dying leaf in autumn. What happens in the deal doesn’t go through? What does that mean for Yahoo! (NASDAQ:YHOO)?

In all likelihood, a drop in share price! Many investors jumped on board at the end of January when Microsoft made the proposal - only to find that their “gem” has been stagnent ever since.

It appears that Yahoo! (NASDAQ:YHOO) is a stock with tremendous downside and a small upside.

Unlike Motorola, Yahoo! has no chance at a bloodletting fire-the-CEO rally (justified or not) because it has already happened. Instead, most of the recent runup in price is a result of the maybe-on-maybe-not acquisition by Microsoft.

So, will Yahoo! reward a patient approach? It doesn’t look that way to me. Its free cash flow in 2006 was $700 million, half the level achieved in 2005. It is only good for a 2.3% free cash flow yield on the current enterprise value. That means essentially all of the return potential has to come from growth - which doesn’t seem like a safe bet given last year’s decline. Sure, the growth rate over the last five years is nearly 45% - but that is coming off of the lowest lows of the Internet Bust. The consensus five-year growth estimate is 24%, including a 20% decline in the current year. By implication, that means the subsequent four years would have to post average growth of nearly 40% annually. Color me skeptical. With an ROE of just 8.27%, assuming growth will be faster than that implies adding debt or issuing new shares unless they can somehow boost the ROE itself - a feat far easier said than done. Coincidentally (or not) that is about in line with the actual year/year growth rate in the latest quarter.

I know, I know - that’s all just academic theory. So let’s consider Yahoo’s businesses to get a feel for what the company can do to boost that ROE and ramp up the earnings growth. According to the latest 10Q, fee-based businesses such as premium mail, web hosting and premium Flickr accounts contribute just 12% of revenue. While they may grow, it is hard to imagine them growing enough to move the needle. That leaves “marketing services” such as HotJobs and display advertising. Somehow, the latest employment report leaves me less than fired up about HotJobs’ prospects. As for display advertising, financial services firms have accounted for anywhere from 12% to 30% of online advertising. A good chunk of that is mortgage refinancing and credit cards - both of which seem likely to suffer as credit standards return to historic norms.

Yahoo! is a great company, with a balance sheet strong enough to carry them through any downturn in the online advertising market. But they aren’t generating enough cash flow today to make waiting for the recovery worthwhile - at least not for me. There are other companies out there that look like safer bets. While Yahoo! could very well return to growth, it just looks too hard to earn a return high enough to compensate for the risk. [1]

It’s a small point but it’s one in a large pattern for Yahoo (YHOO). We still used them for Domain registration which is a fairly innocuous administrative function. When they increased the renewal price 30% to $12.95/year and getting some research done, it turns out that there are services that are much more robust than Yahoo and the best news is that they charge less than half the new Yahoo price.

So one gets vastly improved administration and control at half the cost of Yahoo (again). More importantly, the functionality is improved and every new domain we register is only a third of the Yahoo price.

Yahoo can turn their existing traffic into more money using Google (GOOG), which is perhaps the best indicator of their failure. They are lucky to be getting what they are being offered for their deteriorating online assets. Basically their investment and innovation in building their online services has been far below the market. So their offerings have deteriorated relative to other firms.

there are many things that have gone downhill on Yahoo’s site. Social networking sites and blogs are gaining traffic, traffic that could be going to Yahoo. Much of what Yahoo has now, could be duplicated, perhaps by Google. Google provides similar content and services, such as mail, messenger, maps, etc. and in my opinion, is better. In sum, Yahoo is dependent on creating content and services that will attract visitors to its website.

Yahoo also provides advertising to third parties or affiliate sites, but segment revenue (33%) and margins have been declining. In Q1, segment sales fell 7%, after accounting for the drop in margin (shares more with partner), net revenues declined 13%. Yahoo’s total net revenue increased 9% for Q1. Google’s revenue growth was 42%.

I remember hearing about a Microsoft and Yahoo merger back in May '07, and I thought of the same question -- would they change the name to 'Microsoft!' (with the Yahoooo signature commercial tune)?

In Apr. '07, Yahoo stock fell from $32 to $28. Rumors were circulating that Microsoft would acquire it for $50 billion and the stock shot up to $31.

In Jan. '08, Yahoo fell to $19 after earnings were announced. Shortly after, Microsoft makes a $44.6 billion offer and Yahoo stock rises to $29.

The offer came after Yahoo had a drop both times. The 2nd offer was less than the rumored first offer. Was Microsoft waiting for the drop before the offer? After all, an offer at a stock price of $19, might be much more appealing than a stock offer at $28? Wouldn't the stockholders be more likely to agree the 2nd time around?

Would you like to hear a strange idea?

Is it possible that Yahoo released bad news, knowing that it would lower the stock price, Microsoft would give another offer, the directors would like it, and shareholders might agree to it? I dunno.

Is it a smart move for Microsoft from a competitive aspect? Perhaps. Are they paying too much for it? Probably. Is the internet giant, Google, complaining too much? Probably.

If Google complains and the deal goes through, then it creates competition. Increased competition creates decreased margins for Google and Google's stock drops.

If Google complains and the deal doesn't go through, then the Yahoo stock drops. Yahoo's rich valuation doesn't look as good, which in turn reflects Google's stock, and so Google's stock drops. So, I think Google is a nice short (but do your own due diligence).

What do I think of the valuation?

Would you like to be an analyst? Just multiply EPS*PE = target price. A lot of analysts do that and talk a lot to justify it. I dislike that method.

I make DCF models using a product called 'eVal', which comes in a textbook by Sloan and Lundholm entitled, 'Equity Valuation and Analysis'. I watch my terminal figures and create a model that matches the EPS estimates from analysts, but I like my valuation models a bit more. When I make the model, I get a target price of $9.

Yahoo is overpriced. Sell. Microsoft is paying too much. At least it is Microsoft buying Yahoo and not AOL buying Time Warner. If Google was buying Microsoft then I'd surely complain. Although I think they are paying too much, it looks like Yahoo could help Microsoft's future. As for Google, the company has a tremendous amount of insider selling. High priced stock, insiders selling. Sell.

Ya - Microsoooo-ooooft !

note -- this was originally posted at http://www.investorplaceblogs.com/users/ahknaten/

Increasing competition from Google (GOOG) and Microsoft (MSFT) means that Yahoo! will have to slim down its advertising profit margins. General industry convergence is also problematic, as this kind of competitive price cutting will bleed over from advertising into fees for premium content, etc., reducing other revenue streams as well.

In a matter of days after Yahoo’s announcement last week that merger talks with Microsoft had ended and that the company had instead chosen to sign a search advertising partnership with its No. 1 rival, Google, three executive vice presidents, two senior vice presidents and handful of other well-regarded employees have announced their intention to leave.

The precipitous exodus is hollowing out Yahoo’s senior management ranks. It is also raising new questions about the future of the company and its top executives. Analysts say that the departures suggest that Jerry Yang, the chief executive, and Susan L. Decker, the president, are increasingly isolated.

I remember hearing about a Microsoft and Yahoo merger back in May '07, and I thought of the same question -- would they change the name to 'Microsoft!' (with the Yahoooo signature commercial tune)?

In Apr. '07, Yahoo stock fell from $32 to $28. Rumors were circulating that Microsoft would acquire it for $50 billion and the stock shot up to $31.

In Jan. '08, Yahoo fell to $19 after earnings were announced. Shortly after, Microsoft makes a $44.6 billion offer and Yahoo stock rises to $29.

The offer came after Yahoo had a drop both times. The 2nd offer was less than the rumored first offer. Was Microsoft waiting for the drop before the offer? After all, an offer at a stock price of $19, might be much more appealing than a stock offer at $28? Wouldn't the stockholders be more likely to agree the 2nd time around?

Would you like to hear a strange idea?

Is it possible that Yahoo released bad news, knowing that it would lower the stock price, Microsoft would give another offer, the directors would like it, and shareholders might agree to it? I dunno.

Is it a smart move for Microsoft from a competitive aspect? Perhaps. Are they paying too much for it? Probably. Is the internet giant, Google, complaining too much? Probably.

If Google complains and the deal goes through, then it creates competition. Increased competition creates decreased margins for Google and Google's stock drops.

If Google complains and the deal doesn't go through, then the Yahoo stock drops. Yahoo's rich valuation doesn't look as good, which in turn reflects Google's stock, and so Google's stock drops. So, I think Google is a nice short (but do your own due diligence).

What do I think of the valuation?

Would you like to be an analyst? Just multiply EPS*PE = target price. A lot of analysts do that and talk a lot to justify it. I dislike that method.

I make DCF models using a product called 'eVal', which comes in a textbook by Sloan and Lundholm entitled, 'Equity Valuation and Analysis'. I watch my terminal figures and create a model that matches the EPS estimates from analysts, but I like my valuation models a bit more. When I make the model, I get a target price of $9.

Yahoo is overpriced. Sell. Microsoft is paying too much. At least it is Microsoft buying Yahoo and not AOL buying Time Warner. If Google was buying Microsoft then I'd surely complain. Although I think they are paying too much, it looks like Yahoo could help Microsoft's future. As for Google, the company has a tremendous amount of insider selling. High priced stock, insiders selling. Sell.

Ya - Microsoooo-ooooft !

note -- this was originally posted at http://www.investorplaceblogs.com/users/ahknaten/

On 2008.05.03 Steve Ballmer yanked Microsoft's extra-premium offer (an additional $5B) for Yahoo! Look for Yahoo price to fall into the 19 - $21 range on Monday May 5.

Yahoo may have weakened its core strength by subcontracting search to Google (as part of its ill founded defense against MSFT).

Many are speculating in the press and blogs that Jerry Yang will be hit with shareholder lawsuits in the week of May 5.

While the fat lady has yet to clear her throat on this one, Yahoo's pre MSFT offer stagnation will now resume normal programming.