Overture's Big Score


By David Shook It may be hard to believe that a dot-com survivor closely tied to the moribund online advertising market could grow faster this year than just about any other Internet company. But that's the unlikely story of Overture Services (OVER), the five-year-old Web search engine formerly known as GoTo.com.

While online advertising has been listless for more than a year, Overture has been making gobs of money in an increasingly important Internet niche. No, it doesn't sell banner ads. What it does is auction prime placement on its advertising-based search engine, which is used by nearly all the major portals across the Web.

Think of Overture as the Yellow Pages of the Internet. When you do a search using the service, the results give top placement to the advertisers who paid the most. And everything is focused on e-commerce: Type in "The War of 1812," for example, and you'll get search results for stores selling books about the conflict.

DOMINANT PLAYER. Overture has more than 53,000 advertisers, each paying on average 23 cents every time a person clicks on their prime-placed listings. The company itself remains behind-the-scenes, with most of its results appearing on the pages of MSN, Yahoo!, and America Online. It costs Overture to secure such high-profile placement on the portals, but that expense is more than offset by the revenue it gets from advertisers.

Overture's listings are so ubiquitous and profitable that Goldman Sachs analyst Anthony Noto says the company has "eBay-esque characteristics," noting that it dominates a fast-growing niche of the Web much as thoroughly as eBay does auctions. Noto and other analysts estimate Overture's stock price could climb well beyond the 263% gain over the past year, a rise that saw it trading at $26.25 as of Feb. 20. "Buy the stock," urged an emphatic Noto in a Feb. 20 report.

Not so fast, say other analysts, who don't deny that Overture's success thus far, but regard its stock as pricey at current levels. Just look at its price-to-industry-sales ratio, which measures the company's market capitalization vs. the value of the online advertising market -- $7.9 billion in 2001, according to Web tracking statistics. Overture's annual sales represent about 5% of that market. Yet its stock has a market value of $1.5 billion - equal to roughly 20% of the entire online ad market. This suggests that investors hold immensely high expectations for Overture to deliver stellar growth in years ahead.

GOOGLE JUMPS IN. Plus, Overture could face tough competition from rival search engine Google, the privately owned enterprise that has become the most popular search tool on the Net. It employs 50 mathematicians with PhDs to develop Internet search software based on complicated probability formulas. Just this week, Google announced it has begun offering advertisers pay-per-click listings that will appear alongside the site's regular, math-based search results.

Overture says it can handle the competition. "We feel it would be difficult for any company to emulate what we're doing," says company spokesman Jim Olson, who adds: "But we welcome innovation in the category." Meanwhile, the company is wowing analysts and investors with its performance. It reported robust fourth-quarter sales of $101 million, a 154% gain over the corresponding period in 2000, along with earnings -- yes, some dot-coms really do have earnings -- of $20.8 million, or $0.35 a share, easily beating Wall Street estimates of $0.19.

Yet those results were based on a number of surprisingly lucrative contracts that may not be replicated in the years ahead. While the company expects to deliver 2002 earnings of $442 million, or 93 cents a share -- more than double the 36 cents a share the stock earned in 2001 -- the risk for shareholders may be the nonrenewal of those critical partnerships with AOL and Yahoo.

CONTRACT BRIDGE? These deals allow Overture to provide search results on AOL's portals, giving the company and its advertisers access to millions of hits. The two partnerships are approaching expiration -- at the end of 2002's first quarter in the case of AOL, and in late June for Yahoo. Goldman Sachs' Noto says Overture investors should expect a new partnership with AOL "within weeks." Still, while the company's 2002 earnings guidance doesn't factor in these expected renewals, a failure to achieve one or both could hurt the stock.

Overture does offer businesses a compelling proposition. For the first time in the history of the Web, they have been able to measure how online advertising affects sales. With Overture, the advertiser pays only when an online shopper clicks on one of the links to their site. These are considered to be particularly valuable "hits," because consumers using search engines tend to be looking for something specific and are often poised to make a purchase.

"Never before has there been such accountability and traceability in the ad market," says Jim Pitkow, a search-engine expert and technology pioneer who formerly ran Outrider, a search-technology firm. "It's hard for an advertiser to look at the Overture network and say, 'Er, no thanks.'"

Yet, over the longer term, investors worry that Overture's paid-listings model might lose its appeal, since it doesn't provide objective search results, as does Google. In the wake of Google's announcement that it also will offer advertising-based search results, Overture's stock has fallen about 10%.

UP, DOWN, ALL AROUND. For investors convinced that Overture's business model is a winner, the biggest caveat is the stock's intense volatility. Just look at its roller-coaster ride between Feb. 6 and Feb. 12: At the start of that period, Internet service provider Earthlink (ELNK) announced that it had dropped Overture in favor of Google. Following Earthlink's decision, investors promptly lopped 41% off the company's stock, dragging it down to as low as $18 -- even though Overture said Earthlink's defection would have no material impact.

In the days that followed, however, Overture roared back, buoyed by the surprisingly robust earnings announced on Feb. 12 and news that the company had renewed a contract to provide MSN's millions of users with search results. The stock climbed as high as $32. Since then, it has fallen back to $26.

Clearly, Overture has defied a brutal advertising environment. But investors might still find that it pays to be cautious. Remember, it remains a highly valued stock, trading at 29 times estimated 2002 earnings per share. If it can sustain the pace it has set, Overture's good start could be the prelude to greater profits. Shook covers financial markets for BusinessWeek Online in New York


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