), including its corporate credit rating to 'BBB-' from 'BB+', based on growing roster of paid relationships, further strengthening of key financial measures, and increasing importance of online (through both branded and sponsored search) advertising to marketers.
The rating outlook is stable. Sunnyvale, Calif.-based Yahoo had total debt outstanding of $750 million at June 30, 2004.
The rating on Yahoo reflects the company's well-established Internet brand, high profit margins, good discretionary cash flow generation, and ample cash cushion. These factors are somewhat offset by some concerns regarding the company's revenue and earnings concentration from advertising, competition in sponsored search (especially with MSN's [MSFT
] future entrance as a search engine provider), and the challenges of retaining its market position and relevance in a still evolving Internet market place.
Originally established as an Internet information directory, Yahoo has become a major player in Internet information services and related marketing services. The company provides a wide array of services to both consumers and businesses. The majority of its services are free. However, Yahoo has been aggressively introducing fee-based services, such as Yahoo Plus, on a standalone basis and through partnerships with broadband access providers.
Yahoo's marketing services, including banner ads, sponsored search, paid inclusion, and sponsorships, are well established and are generating the majority of the company's revenue. Standard & Poor's expects sponsored search and branded advertising will continue to experience healthy growth over the next two to four years as consumers spend more time online and marketers shift advertising budget toward online. Yahoo, with its significant online traffic, should benefit greatly from these trends.
The Internet is still evolving as an advertising medium, a source of entertainment and news, and a platform for commerce. As recent purchases of 3721 Network Software Inc. and Kelkoo SA demonstrated, acquisitions will continue to be a significant part of Yahoo's strategy. Growth through acquisition may facilitate achieving the company's growth objectives faster than greenfield development, even though Yahoo has resources available to pursue such internal development. For example, the November, 2003, acquisition of 3721 Network enabled Yahoo to quickly launch Yisou.com, a Chinese-language search engine, in June 2004.
For the 12 months ended June 30, 2004, Yahoo's EBITDA margin (based on generally accepted accounting principles, or GAAP) was 26.8%, a slight decline from 28% at the end of 2003. This is primarily due to the acquisitions of several businesses, which have lower margins. Lease-adjusted total debt to EBITDA was 1.3x for the 12 months ended June 30, 2004, a substantial improvement from 1.9x at December 31, 2003. The improvement was driven by growth in EBITDA as total debt over the period remained the same at $750 million. Yahoo has traditionally been funded through equity issuance and cash flow from operations. The company converted 79% of EBITDA to discretionary cash flow for the 12 months ended June 30, 2004. Its $750 million in convertible notes represent the only debt in the company's capital structure.
Liquidity: Yahoo has strong liquidity with about $2.6 billion in cash, short-term, and long-term marketable securities. Acquisitions and, potentially, share repurchases over the intermediate term are the most likely uses of cash. The company generates discretionary cash flow well in excess of working capital and capital expenditure requirements. Capital expenditures are expected to be relatively stable at about 8% of revenue (or about 25% of EBITDA) and are not expected to restrict healthy discretionary cash flow generation. Maturities are minimal until 2008.
Outlook: A stable outlook conveys the expectation that Yahoo will continue to evolve with the Internet's development as an advertising and commerce platform, either through internal development or acquisitions with promising technology. Furthermore, Yahoo has sufficient liquidity and profitability to withstand short-term volatility. Standard & Poor's anticipates that acquisitions and stock buybacks will be conducted prudently.