Yahoo Focus on Cost Cutting, Needs Top Line Growth to Move Stock
In Yahoo’s (NASDAQ:YHOO) earnings call the company discussed its search partnership with Microsoft (NASDAQ:MSFT) and announced another round of layoffs and discussed that both initiatives should improve its profit margins. [1] The company is struggling in the online advertising which has translated into anemic top line growth and faces increased pressure from players like Facebook, Google (NASDAQ:GOOG), Microsoft and AOL (NYSE:AOL) in the online advertising market.
According to Interactive Advertising Bureau (IAB), the U.S. Internet advertising market grew to $6.4 billion in Q3 2010, which was up 17% over the same period last year. [2] In comparison, Yahoo’s revenue grew by less than 2% over the same period from $1.58 in Q3 2009 to $1.6 billion in Q3 2010. [3] It will be interesting to see if Yahoo continues to streamline its cost structure even though its revenue growth flattens.
We have a $17.88 Trefis price estimate for Yahoo stock, which is about 13% higher than the current market price.
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Cost cutting initiatives to benefit Yahoo in the short term
Yahoo’s revenue sharing arrangement with Microsoft started in Q4 2010 and is a 10 year arrangement between the two companies in which Microsoft will provide the search technology to Yahoo to power its search engine. [1] According to the arrangement, Yahoo will share 12% of the search advertising revenue with Microsoft while Microsoft will bear most of the expenses associated.
In its conference call, Yahoo also announced its plans to layoff 1% of the Yahoo’s workforce, [1] which is the second round of layoffs in recent months. These cost cutting measures are aimed at improving profitability, and we estimate that Yahoo search EBITDA margins could increase from 42% in 2010 to 44% in 2011, in part due to these actions. Long term we expect the margins to stabilize.
However, there could be upside of 2% to our estimate for Yahoo stock if its margins increase at a faster rate to reach 50% by the end of Trefis forecast period.
Long term growth will depend on Yahoo growing revenues
We believe in the short term, cost cutting efforts will be beneficial for Yahoo as it can improve profit margins. However, in the long term, we believe Yahoo still needs to identify ways to grow its top line. Yahoo’s core search business has suffered in the past as it continues to lose its market share mainly to Google. Its market share declined from around 16% in 2006 to 6.4% in 2010, and we estimate could continue to decline to around 5% by the end of Trefis forecast period, which we feel is a conservative estimate.
To highlight the downside effect due to lost market share, there could be a downside of around 10% to our estimate for Yahoo stock if its market share continues its historical declining trend to reach 2% by the end of Trefis forecast period.
You can see the complete $17.88 Trefis Price estimate for Yahoo stock here.
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