Yahoo's Search for Life after Ads


By David Shook While the economic downturn has ravaged all media companies, Yahoo!, the world's largest Internet portal (YHOO), looks especially hard-hit. Following a disappointing third quarter in which Yahoo reported an operating loss of $9.7 million (vs. a $106.8 million profit in the same period last year) on revenues that fell 44%, Yahoo has unwittingly become the poster child for the online advertising collapse.

It's a dubious distinction, but an apt one. Yahoo desperately needs new sources of revenue. Ads still account for 80% of sales -- down from 90% last year. Heavy reliance on ad sales works fine during prosperous times, but it's a nightmare when a recession hits. Investors are unsure whether Yahoo can shift a significantly larger portion of sales from ads to premium subscription services. It's not surprising that its shares have declined 84% in the past year.

Many analysts believe it would be wise to wait before jumping into the stock. Until Yahoo puts forth a compelling strategy for 2002, the stock is a nonstarter, they believe. "Management is laying the groundwork to offer the consumer-based premium services needed to offset the dependence on advertising. However, plans remain [vague], and we believe [Yahoo's non-ad revenue is] at least several quarters away from a contribution that could meaningfully reaccelerate growth," wrote Merrill Lynch analyst Henry Blodget in his third-quarter report on Yahoo.

THREE SCENARIOS. Investors can expect a glimpse of Yahoo's turnaround strategy between now and Nov. 15, when it will host an analyst conference at headquarters in Sunnyvale, Calif. Beyond then, investors could see more details of its survival plan in the next few months. While the company declined to comment for this story, three scenarios are plausible under the stewardship of Hollywood veteran Terry Semel, who took the helm six months ago.

Yahoo's biggest predicament may be that it doesn't own much. Most of the content on its myriad of subportals is supplied by outside companies -- stock brokerages, news magazines, and the like. Wall Street increasingly gripes about Yahoo's need for its own content solutions. One option is entering into a series of long-term content and advertising deals with diversified media companies. Another is that the company begin to use some of its $1.7 billion in cash and its debt-free balance sheet to acquire smaller content providers that would bolster Yahoo's premium services.

Finally, analysts say the company could sell itself to a diversified media behemoth that lacks a strong online presence and could use Yahoo's dominance the way Time Warner uses America Online (AOL) to sell magazines, movies, and music. But so far, its likely suitors -- mainly News Corp. (NWS), Viacom (VIA), and Disney (DIS) -- haven't hinted that a merger is in the offing.

NOT VERY COMPELLING. "In today's world of vertically integrated media companies, while a company like AOL can offer cross-platform ad solutions that reach TV, radio, print, and Internet audiences, Yahoo has only the online presence," says Kavir Dhar of investment bank Jefferies & Co. "It's not very compelling. That's why we think Yahoo would be better off as the Internet marketing arm of a larger diversified media company."

Despite the merger possibilities, Yahoo's stock price has been hammered this year. The startling revenue shortfall has coincided with a big drop in market value. Yahoo now trades at around $12 a share -- a few dollars higher than the company's one-year low of $8 on Sept. 27. Today's price represents a painful reality for those who bought shares when the stock traded at around $70 late in the fall of 2000.

For now, most analysts have a hold rating on Yahoo -- either because they'd like to see a merger or they're frustrated with the lack of earnings guidance from the company for 2002. For fiscal 2001, Jefferies & Co. expects Yahoo to deliver net income of $31 million, or $0.05 a share, on sales of $704 million -- down 37% from a year ago. For next year, however, the picture is so cloudy that Dhar hasn't even issued quarterly earnings estimates.

COMMODITY OFFERINGS. Yahoo's situation calls for drastic measures. If the company decides to go it alone, it's unclear how much of a return the premium services could deliver in the long run. None of Yahoo's existing offerings seem particularly compelling: premium personal ads, digital-photo storage, Web-site- building tools, fantasy football software, unified messaging services, extensive stock-market research, consumer-product reports, auctions, and job listings.

For the most part, such services are the bread-and-butter of other companies or free commodities that can be gleaned elsewhere. For example, eBay dominates the online- auction market, while CBS MarketWatch, AOL, and MSN provide free or discounted corporate financial data.

"There's definitely money to be had," says Gartner Group analyst Joyce Graff, but she adds that Yahoo needs to offer modestly priced services with real substance that are worth the price. She cites Yahoo's discussion groups -- which she uses -- as an example. Thousands exist, on a variety of topics. "Right now they're free, and they're loaded with spam -- even instant-message spam and obnoxious pornographic spam," she says.

TWO SIDES. She thinks Yahoo's discussion-group users would gladly pay a small monthly or annual fee for a service that does a good job of blocking spam and offers computer-virus protection for e-mail attachments. "They've got a lot of work to do to keep that service from becoming extremely annoying, but a modestly priced premium service might be the way to go," says Graff.

Even if Yahoo comes up with a strategy for increasing nonadvertising revenues in the near term, through next year at least, the majority of its revenues will still come from ads, says Dhar. "But remember, there are two sides to that," he says. "If and when online advertising comes back, Yahoo should do better than most."

With any luck, Yahoo can find the right mix of quality advertisers and premium services to hold it through what could be a long winter for the media industry.

Its comfortable cash position and lack of debt are big advantages. And there's every reason to think Semel has a chance at turning the company around. Investors, tempted by the huge drop in price, could find Yahoo's stock especially tantalizing. But it still comes with tremendous risk and should be approached with caution. Shook covers financial markets for BW Online in New York


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