The Temptation That Is Yahoo!


By Amey Stone Wall Street isn't expecting much from Yahoo! (YHOO) these days. Consensus among analysts is that the once highly profitable company will have no earnings to

report for its second quarter on July 11 (which is at least better than a loss). They anticipate second-quarter sales of $175 million, down 36% from $273 million a year ago. And most have little faith that the crumbling online-advertising market will turn around anytime soon, or that consumers or corporations will suddenly start paying for the new services Yahoo offers.

After completing his first 60 days in the chief executive's office, Terry Semel may personally outline some new strategies following the quarterly release. Even there, analysts don't expect much. "I'm not looking for a lot of new news," says Scott Kessler, an Internet analyst with Standard & Poor's. "People use the phrase cautiously optimistic. But I'm cautiously pessimistic on Yahoo," he says.

Are you listening, contrarian investors? All this negative sentiment could add up to a buying opportunity for a struggling Internet leader. The outlook on Yahoo is so bleak that it only took one analyst -- Safa Rashtchy of U.S. Bancorp Piper Jaffray, who rates the stock neutral -- declaring that the online-ad market may have bottomed, to spark a $2.46, or 14%, bounce in the share price, to $19.77 on June 25. Yahoo, which traded as high as $237 a share in January, 2000, fell to a low of $11 this April and has mostly traded in the high-teens since then.

A STAMPEDE? The fact that the stock bounced on such mildly positive news shows investors are out there who want to own Yahoo. It seems they may just be waiting for the first positive sign -- which they don't really have yet -- to buy. "Based on the reaction Monday, any sign that there is a rebound in the online-ad market could definitely bring people stampeding back into the stock," says Paul Shread, a stock analyst with Internet.com, who notes it's also a positive technically that Yahoo so far is mostly holding on to that gain. The stock closed at $18.73 on June 27.

After all, this is Yahoo we're talking about -- a Web site that dominates like no other and an audience that just keeps growing. (The company declined to comment for this story, citing a quiet period before its earnings announcement.) In May, the portal reached 55 million users in the U.S., up from 48 million a year earlier, according to Jupiter Media Metrix. That's more than MSN.com (51 million) and AOL.com (36 million). "You can't really argue with the user base, despite the hit the brand has taken," says Kessler. Worldwide, Yahoo says it had more than 192 million visitors in March, 2001, up from 145 million in March, 2000.

And while the online advertising market may be ugly now, as the industry struggles to figure out what works, when it improves (which, granted, could be a long time coming), Yahoo will benefit from a lot less competition. "If Yahoo is left with 3 to 10 competitors instead of 300 to 1,000, it will have a great chance," says Jordan Rohan, an analyst with Wit Soundview who rates the stock a hold based on its near-term prospects. In the near term, the direct-marketing opportunities of the Web are great, and Yahoo should be able to offer companies more targeted approaches that will have appeal.

COLLECTING FEES. Meantime, the portal is adding more fee-based services -- hopefully the recurring kind that Wall Street loves. Kessler thinks the small but growing business of providing corporate Web sites to both small and large businesses has the most potential. Yahoo is also layering on subscription services for consumers, like its $9.95 a month finance package, which includes real-time quotes and news. It also aims to collect fees for additional e-mail storage, photo hosting, and -- perhaps the biggest opportunity -- its upcoming music-subscription service, PressPlay (see BW Online, 6/21/01, "Digital Music's New Battle Hymn"). For now, many of these paid services are available gratis elsewhere on the Web, but as the Internet shakeout continues, free services are on the decline.

Longer term, as more people get broadband in their homes and thorny questions about how content providers will get paid for digital distribution are resolved, the Web will surely become an important platform for selling entertainment. With Semel (former co-CEO of Warner Bros.) in place, Yahoo should be well positioned there.

And while the July 11 quarterly report isn't likely to shine, Yahoo has already proven its business model works. In the third quarter of 2000, it earned $81 million, or 13 cents a share, on sales of $296 million. Operating margins were a hefty 36%. When sales pick up, its high-margin model will benefit from falling infrastructure costs, points out Michael Davey, technology analyst with Investec Ernst.

ODD CHOICE. So why does the pessimism persist? Plenty of reasons. Chief among them is how long it will take for the online-advertising market to recover. While it may have bottomed, as analysts like U.S. Bancorp's Rashtchy wrote in the recent note that boosted Yahoo's stock, that doesn't mean it will be regaining its former vigor anytime soon. "Things just don't spring back to life," says Rohan. "Right now, there are still hundreds of sites scrapping for ad dollars," while ad buyers continue to shop around for the best deals.

Semel strikes some as an odd choice to steer the company back toward big profits since he doesn't have a background in either advertising or the Web. Kessler worries that the entertainment-industry culture is so different from Silicon Valley that the new CEO will have a tough time fitting in. In addition, Semel is likely to bring in his own people, and investing in a company during a management shakeup is always a risky proposition.

Yahoo's biggest failings come in comparison to AOL Time Warner (AOL), which is a much stronger company and a much less risky stock. It's also valued a lot higher, with a $234 billion market cap, in comparison to Yahoo's $11 billion.

ADD AN ISP? AOL benefits from owning so much content through its Time Warner acquisition. And having 30 million paid subscribers is nothing to sneeze at. Rohan points out that AOL can easily bundle premium services with its monthly fees, giving it a big competitive advantage over Yahoo in that area.

Investec Ernst's Davey thinks Yahoo should consider adding an Internet-access component to its business, perhaps by buying service provider EarthLink (ELNK). He worries that Yahoo isn't attracting the Internet newcomers. "AOL and Microsoft are capturing the new users and not giving them a real reason to escape to Yahoo," he says. Indeed, MSN.com reached 29% more people this May compared to a year earlier, while Yahoo.com's reach grew 15% in that time, according to Jupiter Media Metrix.

Finally, despite its tumbling share price, Yahoo stock is still expensive on an earnings basis. Its price-earnings ratio is above 500, based on 2001 figures, and above 100 on estimated 2002 earnings (which are expected to triple from 2001 levels).

"BETTER TO WAIT"? It's clear that investors are being tough on Yahoo -- and with good reason. Anyone considering an investment in it now should realize they're taking a risk. "Sometimes it's better to wait to see if the strategy is working and maybe pay a little more, than it is to buy here, where the stock price is lower but there's more risk in the business model," says Davey.

Nonetheless, with the bar set this low, Yahoo has plenty of opportunity to shine over the long term. And no matter what the company reports on July 11, there will be a long term. Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column.

Questions or comments? Join in the discussion at our Ask Amey Stone interactive forum


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