Don't Believe The Hype About A Yahoo Turnaround

By Jonathan Berr AAA

Yahoo (Nasdaq:YHOO) Chief Executive Marissa Mayer, one of the most powerful women in business, has recently claimed the company's core display advertising business is starting to show signs of a turnaround. Unfortunately, there may be less to this achievement than meets the eye.

When fees Yahoo paid to partners are excluded - the company's preferred metric - revenue from ad sales, which accounts for about 40% of the company's sales, rose just 2% to $409 million. Though Mayer noted during a recent earnings conference call that the performance of the advertising business and Yahoo's search business represented "an important shift" for the Internet media company, that's a huge exaggeration. As many have said before, one quarter doesn't make a trend and Yahoo has seen many consecutive quarters of declines in its display-ad business.   

Nonetheless, Wall Street is willing to give Yahoo some slack because of the potential payoff from the Alibaba Group IPO. Yahoo owns about a 24% stake in the Chinese Internet company and could stand to reap a $19 billion windfall after the Hangzhou-based company goes public, whenever that happens. Wall Street, though, is starting to press Mayer for details of what's going to happen after the year's most hotly anticipated deal finally occurs and aren't sure if Mayer can back up her words with actions.

The Street Not Totally Sold

Shares of Yahoo climbed after the positive news but the bump was short-lived; YHOO has settled down to a level close to its pre-earnings price. On a price-to-earnings basis, Yahoo trades at a ratio of 29, a discount to rival AOL Inc. (NYSE:AOL), whose valuation is about 37. Yahoo currently trades at a 21% discount to its $42.22 average 52-week price target. The depressed valuation indicates that Wall Street isn't totally sold on Mayer's turnaround plan, any Alibaba windfall notwithstanding. Investors shouldn't add the shares to their portfolio yet until more concrete signs of improvement emerge.

Investors have reason to be skeptical about Mayer's claims about display advertising. She hired Henrique De Castro, a former Google Inc. (Nasdaq:GOOG) colleague, as chief operating officer last year. By all accounts De Castro's tenure was a disaster. The company failed to forge alliances with Madison Avenue and Yahoo's revenue growth withered. Mayer admitted to Wall Street that hiring De Castro was a mistake, and a costly one at that. His severance package reportedly was $58 million, a shockingly high figure.

To make matters worse, Yahoo's share of the display-advertising market has been slipping for years. Marketers spend more money with Google, Facebook, Inc. (Nasdaq:FB) and Microsoft Corp. (Nasdaq:MSFT). As of the end of last year, eMarketer pegged Yahoo's share at 5.8%, well behind Google, which had 39%. Under Mayer, Yahoo has made huge bets on original content, bringing media personalities such as broadcaster Katie Couric and former New York Times columnist David Pogue on board. Meanwhile, it has spent $1 billion on the popular blogging site Tumblr and has revamped many of its features such as the photo-sharing site Flickr and has added new features such as the popular app Summly.    

Yahoo managed to sell 7% more display ads in the quarter, more than double the 3% increase it saw in the fourth quarter. However, there is a huge caveat to that statistic: the price per ad fell 5%. Though that represents a sales improvement over previous quarters, it is a worrisome trend nonetheless. It shows that advertisers are scaling back spending with Yahoo and ratcheting it up with rivals such as Facebook, which recently reported a blowout quarter. Unfortunately for Sunnyvale, Calif.-based company, display ads are like vinyl records for marketers: relics of a bygone era. Advertisers are shifting spending to more targeted forms of advertising such as search and sponsorships. Moreover, those who buy display advertisements aren't willing to pay much for them and thanks to the growth of programmatic sales, they don't have to.   

Programmatic ad sales are automated auctions that match buyers are sellers. For companies such as Yahoo, they are a mixed blessing. One the one hand, they move inventory. Unfortunately, they move these ads at rock-bottom prices. Programmatic ad sales are expected to surge in the coming years, rising from $12 billion in 2012 to $32.6 billion in 2017, according to Magna Global. 

The Bottom Line

Even though Mayer has talked a good game about the new Yahoo, she still needs to improve the company's core display-ad business for analysts to believe her turnaround is for real. And with ad rates falling, the clock is ticking on reshaping that business.

--Jonathan Berr does not own shares of the aforementioned stocks.

 

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