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The Web portal and chipmaking giant operate in areas where demand is rising at a healthy clip. So why aren't they performing better?
Investors seeking early indications of the tech sector's health typically turn to earnings reports from Yahoo! (YHOO) and Intel (INTC) for guidance. As one of the Web's largest media companies, Yahoo is considered a bellwether for the online advertising market. Intel, the world's largest maker of computer chips, is a harbinger of demand for computers and the components that make them run.
Second-quarter reports from Intel and Yahoo released July 17 belied strength in all those areas—and showed why both are so hard-pressed to benefit from it.
Yahoo said net income fell to $160.5 million in the three months ending June 30, from $164.3 million a year earlier, with per-share earnings unchanged at 11 cents. Yahoo also lowered its sales forecast for the third quarter to $1.17 billion from $1.31 billion, compared with earlier guidance of $1.2 billion to $1.3 billion.
Not Enough Revenue
Yahoo's results contrast with the healthy growth of the overall online advertising market. According to research firm eMarketer, online advertising will swell more than 28% to $21.7 billion in 2007 from $16.9 billion in 2006. EMarketer expects Google's (GOOG) ad revenue to rise by 45% in 2007. Yahoo, on the other hand, expects full-year revenues to fall between $4.89 billion and $5.19 billion, a decline from last year's $6.4 billion.
Company executives are well aware of Yahoo's plight. "There is a significant gap between where Yahoo is and where it needs to be," Yahoo Chief Executive Officer Jerry Yang said on a conference call with analysts. "We are becoming smaller as part of the Web's overall activity." Yang in June replaced Terry Semel as CEO to help Yahoo trim Google's lead in Web search and the ad revenue it generates. As one of his first acts as CEO, Yang promised Yahoo would undergo an extensive 100-day review. Yahoo President Susan Decker highlighted several recent errors, including the failure to more swiftly revamp the company's method for matching ads with search results—a lucrative talent perfected by Google. Decker also lamented Yahoo's reluctance to shake up its staff. "We have been at times risk-averse in making personnel decisions," said Decker.
Yahoo's stock declined more than 4% to $26.37 following the announcement. "The continued uncertainty in nearly every segment of Yahoo, and a 100-day strategic review result in limited visibility of estimates, growth, and thus valuation," Goldman Sachs (GS) analyst Anthony Noto wrote in a July 17 note to investors. "We still recommend staying on the sidelines as transitions typically take longer and result in deeper cuts than expected."
Losing the War?
Like Yahoo, Intel also is failing to fully benefit from rising demand in the areas of tech it dominates. The chipmaker said net income rose 44% to $1.28 billion as sales rose 8% to $8.7 billion amid demand Intel CEO Paul Otellini described as "strong." Yet, Intel's shares declined 4.9% to $25.05 in extended trading.
Intel's problem is a price war with archrival Advanced Micro Devices (AMD) that's putting pressure on margins. The company's gross margin, a yardstick of profitability, was 46.9%, suggesting Intel will have an uphill climb meeting its full-year forecast for margins of 51%. "Pricing had something to do with it," says James Ragan, an analyst with Crowell, Weedon & Co.. Price pressure is particularly severe in the low end of the PC market. Intel was also beset by slumping demand for chips used in mobile phones, but is spinning off the business that specializes in those chips.
Intel is calling for sales of $9 billion to $9.6 billion in the current quarter, generally in line with expectations, and expects gross margins to recover this year. "We are just positioning ourselves for a strong second half," Intel Chief Financial Officer Andy Bryant said during the earnings conference call.
Yahoo's guidance, however, indicates that the company has a long way to go toward fixing its problems. On top of its full-year projected revenue decline, Yahoo forecast third-quarter net sales of $1.17 billion to $1.31 billion—falling short of some analysts' own estimates. To right the ship, Yahoo is counting on a new search-ad system called Panama that's designed to better match search queries with ads most likely to generate revenue (see BusinessWeek, 3/8/07, "Panama's Promising Early Results").
According to Decker, revenue-per-search is up 15% to 20% since Panama's U.S. rollout earlier this year. "The market is clearly more responsive…than we initially planned for," said Decker. She also said Yahoo's emphasis on targeting ads based on the Web sites people visit within its network and on those it has information about has resulted in higher advertising returns from some of Yahoo's lower-value, less targeted sites.
Decker also noted some success from Yahoo's Smart Ads program, which targets ads based on the sites visited by individual computers. Yahoo executives expressed optimism that the recent integration of the search and display advertising sales teams would help make it easier for marketers to buy more ads from Yahoo as well as encourage smaller advertisers to do business with the company. "Simplifying the sales process is a good step," says Marianne Wolk, research analyst at Susquehanna Financial Group.
Still, Yahoo executives acknowledged that much needs to be done. Besides fessing up to mistakes under Semel (see BusinessWeek, 6/19/07, "Yahoo! Turns to Yang"), Yang and Decker spent the first half of the conference call outlining a plan to accelerate growth.
Yang said Yahoo will continue to invest in its advertising capabilities. Part of this investment will come from people. Yahoo plans to increase the company headcount, which already stands at more than 12,000 employees. The new people will help Yahoo improve its technology and make more money from search and brand advertising, says Yang. To offset that investment, Yahoo also plans to cut some of its less profitable businesses. "We are investing for growth," says Yang. "There are no sacred cows."
One area where Yahoo will concentrate its efforts is in its new partnership with Right Media, which the company acquired for $725 million. The online advertising exchange helps Yahoo serve more targeted ads both on and off its network, thus increasing revenues (see BusinessWeek, 5/1/07, "The Promise of Online Display Ads").
In order to grow in line with the online advertising market, however, Yahoo will need to rely on more than Right Media. The company must figure out how to fight increased competition for ad dollars—from social networks such as Facebook and News Corp.'s (NWS) MySpace.com, and a myriad of other sites where online audiences are spending more time. "There is a lot of evidence that the branded advertising market is getting more fragmented and advertisers are advertising on a lot of smaller sites in addition to Yahoo," Wolk says.
That means coming up with creative ways to attract, and keep, the attention of audiences as well as advertisers. Yang, for one, is promising to spearhead just that kind of creativity by focusing more on attracting talented people and fostering the kind of technological innovation that has transformed small startups into Yahoo's major competitors. "This is a company that I believe can and will win," he said.