Whether it's because of my Wall Street background or it's just legitimately funny on its own, the Underpants Gnome episode of South Park is one of my all-time favorites. I particularly love the explanation of the business plan – Step One: Collect Underpants, Step Two: ?, Step Three: Profit – as it so well captured the silliness of tech bubbles and pilloried the ridiculousness of the CEOs and corporate boards of the era.

I'm not sure Yahoo! (Nasdaq:YHOO) shareholders see quite the same humor in it, though, as the company's past acquisitions of GeoCities, HotJobs, AltaVista fit that model pretty well. Now we have Yahoo! spending over $1 billion of shareholders' money on Tumblr. Management promises that this time will be different, and how this deal goes over the next couple of years will say a lot about whether new management will produce different results for this long-struggling internet company.

SEE: Evaluating A Company’s Management

The Deal To Be
After a somewhat extended period of rumor, Yahoo! confirmed Monday morning that it will acquire the internet/social media company Tumblr for $1.1 billion in cash. Yahoo! has pledged to continue to operate Tumblr as an independent and separate company after the deal, along with a public promise “not to screw it up”.

For that $1.1 billion, Yahoo! is getting a blogging and social networking site that boasts upwards of 180 million active global users, with an estimated 37 million mobile users. Yahoo! may also be buying into a business about to show real operating leverage– Forbes has estimated that Tumblr earned $13 million in revenue in 2012 and was targeting $100 million in revenue for 2013. On the expense side, Forbes estimated $25 million in 2012 operating expenses and $40 million for 2013, but no mention was made of the cash flow situation of the business.

SEE: Analyzing An Acquisition Announcement

Can Yahoo! Add Value?
One of the critical questions I have about this deal is the extent to which Yahoo! can really add any value. Obviously Tumblr didn't need Yahoo! to get to this point, and the company has done well on its own against the likes of WordPress  and Google's (Nasdaq:GOOG) Blogger. What's more, despite management's promise not to screw up Tumblr, it's in the nature of corporate executives to think that their active involvement or “leadership” will make things better. Sometimes, as in the case of Apple (Nasdaq:AAPL) under Steve Jobs, that's for the best, but many quality companies have been ruined by their acquisition by larger companies.

So back to the original question – can Yahoo! add value here? It sounds as though the combination of Tumblr with Yahoo!'s ad technology could definitely enhance the revenue, earnings, and cash flow of Tumblr. That same Forbes discussion of Tumblr's profitability suggested that monetizing the site similar to how Facebook (Nasdaq:FB) has proceeded would generate substantial profits.

It would likely also generate substantial user outrage. And there's the rub. There could be a lot of synergies between Tumblr and existing Yahoo! properties in areas like sports, finance and so on, not to mention the aforesaid leverage with Yahoo!'s advertising capabilities. If Yahoo! handles it right, it could be a YouTube-esque type of deal. If Yahoo! handles it badly, users will be outraged, leave the site, and leave Yahoo! with another smoking crater of value destruction.

SEE: Biggest Merger and Acquisition Disasters

The Bottom Line
I don't want to belabor the “Yahoo! can't do anything right” cliché. This company is still named Yahoo!, but the management team is different, the business strategy is different, and the competitive environment with Google, IAC/InterActive (Nasdaq:IACI), Microsoft (Nasdaq:MSFT), Facebook, and others is different. At a minimum, Marissa Mayer deserves the opportunity to prove whether it is different this time.

That said, Mayer's window of opportunity is not indefinite. If site and traffic data shows users fleeing Tumblr, and/or if Yahoo! stumbles in its attempts to judiciously monetize and leverage Tumblr, shareholders are going to respond accordingly. With a 70% jump over the past year, attitudes have already started to change on Yahoo! and the fate of this deal will go a long way towards answering the question of whether Yahoo! has a second act as a growth company.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Fundamental Analysis

    Mergers And Acquisitions: Understanding Takeovers

    In the dramatic world of M&As, battleground terms meld with bizarre metaphors to form the language of the game.
  2. Investing Basics

    Warding Off Hostile Takeovers

    The purpose of this article is to provide a general overview of hostile corporate takeovers, while highlighting a general course of action against such activity. This article provides basic information ...
  3. Fundamental Analysis

    Key Players In Mergers And Acquisitions

    Strategic acquisition is becoming a part of doing business. Discover the different types of investor groups involved.
  4. Forex Education

    Mergers & Acquisitions: An Avenue For Profitable Trades

    When major corporate transactions have a big impact on the currency markets, you can benefit.
  5. Bonds & Fixed Income

    Trademarks Of A Takeover Target

    These tips can lead you to little companies with big prospects.
  6. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  7. Active Trading Fundamentals

    The Biggest Private Equity Firms in Los Angeles

    Learn why Los Angeles is a thriving market for private equity, and identify the five largest private equity firms operating in the city.
  8. Investing

    The Rise of Corporate Venture Capital

    After the success of Google Ventures, corporate venture capital is an increasingly popular diversification and hedging tool for many large corporations.
  9. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  10. Investing

    What’s Plaguing Twitter and Yelp?

    Yelp and Twitter have recently become grounded in reality and unable to justify their sky-high stock valuations.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Poison Put

    A takeover defense strategy in which the target company issues ...
  3. Assented Stock

    A share of stock owned by a shareholder who has agreed to a takeover.
  4. Back-End Plan

    An anti-acquisition strategy in which the target company provides ...
  5. Voting Poison Pill Plan

    An anti-takeover strategy in which the company being targeted ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!