Yahoo's Next Search: A New CEO?

An 11% decline in profits raises questions about Terry Semel's longevity and overshadows the expansion of the search engine's eBay partnership

Terry Semel, Yahoo chairman and CEO Daniel Acker/Bloomberg News

by Catherine Holahan

Panama's patina has officially worn off. A disappointing first-quarter earnings report on Apr. 17 largely erased investor enthusiasm about Yahoo!'s new search advertising software and had some analysts openly speculating whether CEO Terry Semel will soon be out the door.

Yahoo said profits fell 11%, to $958 million, on $1.67 billion in sales. Chief Financial Officer Sue Decker attributed the decline to the phaseout of Microsoft's search ad business and rising costs of driving traffic to Yahoo sites.

Investors sent the stock tumbling more than 8%, to $29.48, in after-hours trading. It has been 18 months since Microsoft (MSFT) informed Yahoo (YHOO) that it would lose the MSN portal as a source of search advertising revenue. Wall Street clearly expected that MSN should have had far less impact by now and that Yahoo's revenue from other sources would offset the MSN-related shortfall. Indeed, Yahoo's stock was up 1.5% before the earnings announcement. "Results were well below heightened expectations, and the growth does not justify the value," wrote Goldman Sachs (GS) analyst Anthony Noto in a note to investors.

Results Below Expectations

The news erased much of the goodwill that investors have felt toward Yahoo, thanks to what appears to be a successful launch of the Panama search advertising software, and had some analysts openly speculating whether this would be the end of Semel's tenure. "The writing is on the wall," wrote Jackson Securities analyst Brian Bolan, speculating that CFO Decker could soon take the helm. "Another quarter with a bottom-line miss will be the last one for Semel."

Microsoft launched its own adCenter in late 2005 and gradually began phasing out Yahoo's search marketing ads. Decker said that the software giant was now finished with the phaseout. To compensate for the Microsoft loss and expand its search marketing business, Yahoo has been striking partnerships to deliver search ads on other properties outside of Yahoo sites and encourage more marketers to work with Yahoo. The company cited the expansion of its newspaper consortium, which enables Yahoo to provide search and serve ads on online newspaper sites, including those owned by McClatchy (MNI). Decker also highlighted the company's recent search ad deal with Viacom (VIA) (see BusinessWeek.com, 4/11/07, "Viacom Spurns Google for Yahoo"). "We are committed to being the industry partner of choice," said Decker during a conference call with analysts.

Incentive for Small-Biz Customers

The disappointing earnings overshadowed news on another front: Yahoo will expand a key partnership with online auction service eBay (EBAY). During the call, Yahoo said its alliance, initially outlined in May, 2006, will include PayPal, eBay's online payment processor, and Yahoo's revamped search-ad ranking system. "We have found a fantastic partner in PayPal," said Rich Riley, a Yahoo senior vice-president who hammered out the deal.

The broadened Yahoo and eBay pact, reached after more than 10 months of talks, gives PayPal's millions of business customers incentives to use the newly revamped Yahoo marketing tool Panama, which places ads alongside search results. It also encourages Yahoo's small-business customers to use PayPal to process payments. Incentives include waivers of payment processing fees and Web hosting fees. The companies didn't disclose financial terms.