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Can Yahoo be a Tech Leader Again?
Posted by: Matthew Indyke and Brian Zen (IP Logged)
Date: January 12, 2013 02:04PM

During the third quarter of 2012, David Einhorn, Daniel Loeb, Joel Greenblatt and Ray Dalio bought into Yahoo (YHOO), one of the leading providers of Internet information. The company was once the leading information website before competitors came along and found a way to deliver better results. Then an outdated platform eventually did Yahoo in. Consumers quickly gravitated towards newer and more reliable websites that offered a better search engine. Yahoo, furthermore, became irrelevant as most people who worked for the company were incompetent or appeared uninterested in reviving its business. Yahoo became nothing more than a stagnant business that offered nothing but inferior qualities and little to no advantages over its closest competitors.

But this has all started changing recently with a revamped management team more serious and focused on reviving Yahoo, a renewed willingness to invest and grow company resources, and a surplus of cash that increases the company’s flexibility. Yahoo could be gaining steam for the following reasons:

· New CEO Marissa Mayer has brought a new attitude to Yahoo, promising to implement plenty of changes to help move the company toward a more sustainable future, something not observed in the slew of recent CEOs that turned out to be failed hires. Since Mayer stepped in, Yahoo’s stock has risen close to 25% to a level not reached for a few years and its P/E of 5.96 and P/B of 1.5 suggest the company may have further upside.

· Yahoo’s revenue and operating income have increased thanks to secular growth in online advertising, an industry which grew by 22% from the previous year. The company’s revenue increases resulted in a skyrocketing profit margin. There are opportunities for Yahoo to increase its revenues even more by investing in capabilities that change the mix of manual versus automatic buying for advertisers, creating their own ad campaign across its platforms, and enhancing its diverse network of mobile apps.

· Yahoo has built up an impressive portfolio of products over the years, giving the company approximately $4.5 billion in cash, an above-average return on investment of 9.9%, and an outstanding return on equity of 28.3%. These numbers have increased the company’s liquidity and ability to engage in acquisitions of companies that would help Yahoo’s long-term growth.

New Management Leading Yahoo on an Upward Trend

Marissa Mayer was hired this past July as Yahoo's fourth CEO in three years. The company’s stock has since risen by 25% to $19.50 per share and closing in on $20, uncharted territory for Yahoo in the past few years. Part of the rise is due to the overall market rally. Some analysts suggest the stock price increase is a result of the market believing in Mayer and the new management team. The company’s P/E of 5.96 and P/B of 1.5 are both very low numbers for a tech company. Yahoo is focused on improving areas in which it is already a leader and Mayer has recognized key opportunities for improvement. Mayer has two big picture goals for the company: switch from a media company to a technology company, and increase the number of tangible product offerings while moving away from being just an Internet site. Yahoo is developing more technologies to conveniently bring its users the media they want, when they want it. The articulation and emphasis of these strategies are increasing the investor perception that the company has at last found the right management team to execute on the ongoing turnaround.

And a key aspect of Mayer's growth strategy is bringing in more talent to the company. A problem Yahoo has had in the past is that people simply do not want to work there. Other than Mayer, there have been four significant changes in Yahoo's executive management in the last six months. Ken Goldman was hired as CFO and has three decades of experience in software and Internet companies. Henrique de Castro was brought in as COO to take charge of the strategic and operational management of Yahoo's sales, operations, media, and business development. De Castro has past experience building display advertising businesses from scratch and overseeing the advertising platforms of tech companies. Jackie Reses is now Vice President of People and Development and in charge of hiring and training new employees. And finally, there is Chief Marketing Officer Kathy Savitt, who is responsible for worldwide marketing and branding.

Advertising and Monetization of Mobile Apps Lifting Revenues and Profit Margin

Yahoo’s revenue is up 2% compared to 2011 and its search revenue is growing in the double digits. Operating income for the third quarter of 2012 just saw a $177 million increase compared to 2011 and its profit margin has reached a level not seen in the last few years during Yahoo’s demise. Its 80% profit margin is well above one that was in the 20% range within the past year. Moreover, the company has come a long way from a negative profit margin that affected Yahoo’s well-being three years ago. There are initiatives in place to improve revenues and profit margins even more going forward. The upside Yahoo sees in its business is the opportunity to make ads within its user-interface perform better on a click-through-rate basis, like integrating search across all of its sites and applications to grow revenue. These changes, among others, have helped increase revenue-per-search and cost-per-click.

Mobile monetization is another huge profit-making opportunity and Yahoo currently has 76 android and iOS applications. The company already possesses some exciting apps like Finance, Mail, News, Sports, Games, Messenger, Groups, as well as Fantasy sports, which offer advertisers platforms to reach its 262 million user base. Yahoo's goal is to optimize this number going forward and become the dominant provider of daily smart phone uses like checking the weather, sports scores, and the stock market, among many things. In addition to mobilization, Yahoo is looking to improve the personalization aspect of these apps that have always been a large draw for its desktop website. If Yahoo can expand its advertising revenue through mobile monetization, it can generate even greater wealth for its shareholders in the future.

Utilizing Cash to Make Meaningful Acquisitions

Yahoo has an impressive portfolio of web-based search and advertising services that has contributed to $4.5 billion in cash and investments on its balance sheet. The $4.5 billion in cash makes up more than half of the company’s book value. On top of that, Yahoo's return on investment (ROI) is 9.9%, better than the industry average of 5% and its return on equity (ROE) sits at 28.3%. The cash surplus and high returns position the company to grow in the areas it wants to when it wants, increasing its ability to engage in acquisitions designed to enhance Yahoo’s portfolio. There are many acquisition targets available with Yahoo's cash surplus and high returns and Mayer is looking at targets with price tags within a range of $10 to $100 million.

Yahoo is considering two types of acquisitions: companies that increase user engagement (particularly mobile) and those that boost advertising returns. Yahoo is turning itself into a company where users can refer to it for basic services like news, scores, and weather, and any acquisitions it would make are intended to help strengthen its business in those areas. Having extra cash is a plus when it comes to improving a specific area of your business and expanding services so Yahoo has the resources in place to grow itself at a high rate.

Weakening Market Share in Internet Search Traffic

Yahoo, nevertheless, has its share of concerns pertaining to heavy competition in the technology sector and deteriorating market share in products and services where its closest competitors have edges. Yahoo's market position should raise concerns from investors, as it holds on to just 12% of search traffic market share, a meager amount compared to competing search engines. Internet searches have become an indispensable part of life, helping people to find everything much quicker and more efficiently than in the past. Data provider comScore estimates that Yahoo held a 12.2% market share in search traffic recently, versus 16% for Microsoft (MSFT) and 67% for Google (GOOG). This is problematic for Yahoo considering that search accounts for about a third of the company's net revenue.

When Yahoo first entered the Internet landscape, consumers primarily associated the company with one where Internet searches could be performed. But Yahoo became significantly weaker in this area of Internet searches with passing time and consumers gradually veered away from the company for that reason. What Yahoo lacks is an uncluttered home page and a search engine that produces fast and relevant results, areas where Google has a clear edge, not to mention there is no sign of Google letting up any time soon in its superior quality of search results. Although CEO Mayer is working to bring Yahoo in a positive direction and change its focus, Yahoo’s competitors already offer the simplistic and ease-of-use features that make its websites highly navigable and user-friendly. Therefore, it would take a lot of time and brilliant marketing to win consumers over to Yahoo over Google or Microsoft. Consumers are more likely to search on a website where everything is offered in one place and less clicking is involved to get from one page to another.

Yahoo’s Lack of an Operating System

Yahoo, unlike its closest competitors, also does not have its own operating system on any particular platform or device. This can put it at a disadvantage as it does not give Yahoo the opportunity to use the operating system to leverage the rest of its products like similar tech companies. A solid competitive advantage in this area would ensure repeat visitors. But when it comes to overall operating platform, Yahoo lacks the advantage. Yahoo, with its current setup, will be hard-pressed to compete with Apple (AAPL) and its array of mobile products, Google and its diverse portfolio of products and platforms, and Microsoft and its collection of operating systems across different types of devices.

Yahoo uses many different platforms without ever having owned an individual operating system. When a single consumer uses multiple platforms, it makes it difficult for Yahoo to provide high-quality service to consumers and moreover, provide comprehensive data on its users to advertisers. It is a potential risk that users will shy away from some of Yahoo's products without an organized operating system because there are simply too many to choose from, making it difficult to synchronize them. Yahoo must start to revamp its own line of products and get creative with a grouping system in order to get on par with competitors. Developing its own operating system to handle the assortment of apps it possesses would be a positive step in the right direction for Yahoo.

The Shaky and Uncertain Future of the Tech Industry

Yahoo is a technology company and tech stocks have generally been very susceptible to sudden changes in valuation. Although the stock price of Yahoo has increased at a high rate recently, the company’s price is still depressed from normal levels. Yahoo has never hit the same highs it had during the dot com crash of the early 2000’s. As an investor, it is important to be careful to understand the company you are investing in, especially a technology company, because technology can change daily, causing a company to lose its value almost instantly. Obviously, Yahoo's key play is in the online advertising market, which remains one of the most attractive growth segments of the tech economy. The company has been hedging its deteriorating display ad revenues by tapping into the mobile segment more heavily.

What to Expect of Yahoo in the Next Year

Yahoo has some good upside going into this year. The stock that was once a laggard in the technology sector is starting to show signs of improvement. There is finally a capable management team in place and it has the cash to do what the new team finds necessary to turn the company around and spur growth. However, the media seems overeager to anoint new CEO Marissa Mayer as the company’s savior, and there are legitimate worries that management will be tempted to engage in some attention-getting but unproductive strategic initiative rather than focus on the core business. Demand for display advertising is also putting pressure on the company, but Yahoo’s well-known global brand and 700 million users should help it to better penetrate the mobile market.

Disclosure: Authors have no position in Yahoo.



Guru Discussed: Daniel Loeb: Current Portfolio, Stock Picks
Ray Dalio: Current Portfolio, Stock Picks
Joel Greenblatt: Current Portfolio, Stock Picks
David Einhor: Current Portfolio, Stock Picks
Stocks Discussed: YHOO, MSFT, GOOG, AAPL,
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