Yahoo! Still Has So Much To Do

By Stephen D. Simpson, CFA | January 31, 2013 AAA

There's still life in Yahoo! (Nasdaq:YHOO), but there's also still a long and difficult road ahead of the company. Marissa Mayer has been at the helm for only a short time and fundamental repositionings in strategy, culture, and so on do not happen overnight. While Yahoo! most definitely faces serious threats from the likes of Google (Nasdaq:GOOG) and Facebook (Nasdaq:FB), the company has assets and opportunities that still offer some hope.

SEE: A Primer On Investing In The Tech Industry

Some Signs of Progress in the Fourth Quarter
Fourth quarter results for Yahoo! were certainly not flawless, but the company showed some signs of progress. The company also successfully monetized some of its non-operating assets and returned a portion of that capital to shareholders.

Gross revenue rose 1.6% from last year, but 12% from the third quarter, with net revenue improving 5 and 12%, respectively. On a net revenue basis, that's the best growth Yahoo! has shown in approximately four years. Net display declined 5% on a 10% decline in the number of ads sold, while net search rose 14% on an 11% increase in paid clicks (marking four straight quarters of growth).

Profitability wasn't perfect, but the company did alright relative to sell-side expectations. Gross margin fell about three points from last year, but did improve almost two-and-a-half points from the third quarter. Operating income was likewise mixed - down 22% from last year, but up 25% from the third quarter.

SEE: 3 Big Reasons Marissa Mayer's Hiring Is A Huge Win For Yahoo!

Is It Real, Is It Meaningful, and Is It Sustainable?
Yahoo's performance looks pretty good relative to its recent operating history, but a quick look at the revenue results from Google shows that the company's performance is not nearly as impressive on a relative basis. Yahoo's results in search were helped at least in part by guaranteed payments from Microsoft (Nasdaq:MSFT) and the company still has only single-digit share in the search market. Likewise, the company is losing ground to companies like Google and Facebook on the display side.

The Assets Are There, but Can They Be Translated into Revenue?
It has been a long time since Yahoo! has worked as a business, but that doesn't mean that it doesn't have viable and potentially valuable assets.

The company's sites attract hundreds of millions of unique visitors every month. Yahoo's email business has lost share to Google's Gmail, but it has held up against Microsoft's Hotmail and AOL (NYSE:AOL), and still has over one-third share according to comScore. What's more, the company's sites hold strong share in sports, news and finance against rivals like Disney (NYSE:DIS), Comcast (Nasdaq:CMCSA), Google and Time Warner (NYSE:TWX).

I don't think it's a trivial detail that Yahoo! has succeeded in areas (like finance) where Google has really struggled. The question, however, is the extent to which Yahoo! can monetize this. It would seem reasonable or logical that sites like Yahoo! Sports and Yahoo! Finance would be popular destinations on mobile devices, and that should give the company a platform to do well in mobile. Unfortunately, words like "seem" and "should" are the problem - Yahoo! hasn't done it yet, and may never be able to figure out how to make economic rents off of these valuable properties.

SEE: Guide To Excel For Finance

The Bottom Line
I don't want to dismiss the potential value of Yahoo! Japan or the remaining stake in Alibaba. That said, liquidating its stakes in these other businesses is a one-time windfall that doesn't really change the long-term equation for the company.

Most analysts do not assume any significant long-term revenue growth for Yahoo! - modeling growth rates in the low single digits at best. At the same time, I don't yet see the argument for projecting substantially higher free cash flow margins into the future. That suggests a low forward free cash flow growth rate based on current information, and not a very appealing fair value for the shares. Bulls will argue that Mayer's plan(s) could turn around this business and lead to substantially better growth down the line, and that may very well be true, but I don't think there's enough evidence today to support a substantially higher value on the shares.

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

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