Can Yahoo Survive In Its Current Form?

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Yahoo!

Yahoo! (NASDAQ:YHOO) profitability measured in terms of EBITDA margin is less than half of that of Google and its revenues have declined by more than 30% since 2008. The company continues to spend a significant amount on product development and sales and marketing, without any corresponding increase in sales.While both companies follow a different approach to their businesses, in order to bring its margins close to Google’s, with expenses intact, Yahoo needs to double its revenues. Google built it business around discovering things on the internet (through its web crawler application) and monetized ads shown against the search results, while Yahoo focussed on delivering content and monetized this content by showing ads against it. In order to improve its business, Yahoo sold most of its search engine patent to Microsft’s Bing in 2007. As a result, we believe that the company lost its competitive edge in the search ads vertical and, despite a renewed push in search technology with a new algorithm; it will not be able to gain a sustainable improvement in market share to increase its revenues. We believe that for Yahoo to boost its revenues, it needs to morph into a tightly integrated ads company that can deliver ads across screen sizes (tablets, mobiles and desktop) and media (content and videos). Over the past two years, the company is expanding its footprint in the ads technology space in order to carve a niche for itself. Specifically, it is targeting programmatic ads in the video and mobile space through Bright roll and Flurry and capturing a market share in this space will be important for its valuation.

See our complete analysis of Yahoo! here

What Are The Issues Plaguing Yahoo’s Revenue Growth?

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Yahoo’s revenues have declined by more than 30% since 2008.  After a sharp decrease in revenues between 2008 and 2011, the growth has been flat in the last four years. On the other hand, Google’s revenues have increased by nearly 200% between 2009 and 2014, with the compounded annual growth rate in the past two years being 16%. It is clear that Yahoo needs to improve the depth and breadth of its content. While the company is investing heavily for the development of original content, it is also tying up with sports associations such as NFL to stream live sports online. However, all these are costly propositions and might not yield the desired results due to lack of a better monetization mechanism.

Google has been able to monetize its content either through search ads (product listing) or display and video ads shown against videos on YouTube. It also has a strong network of third party affiliates that help it increase its reach. Yahoo, which has been slow to react, is playing catch up and is looking to supplement its content with new technologies in mobile and video space.  However, these additions and product refreshes have yet to generate top line growth, which continues to elude Yahoo.

Why Are Yahoo’s Margins Taking A Hit?

According to our estimates, Google’s EBITDA margin for its PC and Mobile search business is around 60% while the same metric for Yahoo is around 30%. This significant difference is primarily due to very high spending by Yahoo on product development and sales and marketing expenses  as a percentage of revenues (accounting for 60% of Yahoo’s revenues for the fiscal year 2014, compared to 30% of Google). In short, Yahoo’s ads business lacks economy of scale that comes from access to quality and quantity of content.

For Yahoo to generate an EBITDA margin which is close to Google’s, it needs to double its revenues without increasing the marketing and product development costs any further. This is unlikely, in our opinion. Yahoo’s current search market share is around 7% and we do not expect this market share to increase significantly over the forecast period. With no operating leverage, we do not expect Yahoo’s margins to increase substantially in future.

Perhaps, Yahoo Needs to Reinvent Itself

Yahoo’s current efforts to improve its content offering and gain market share have not yielded results. It is neither identified as an online search company (since it lacks breadth in terms of content) like Google nor is it a social ads company as it lacks depth on user engagement that helps Facebook deliver more targeted ads. In light of these trends, Yahoo is trying to reinvent itself by increasing its footprint in the video content and mobile ad offering. It is producing original content for its website. It is also streaming live sports as an experiment to grab more eyeballs.  Furthermore, it is aggressively pursuing the programmatic ads market. It acquired Bring Roll in November 2014 to target the programmatic video ads vertical. In July 2014, it acquired Flurry, a mobile analytics firm.  Yahoo launched the unified ad marketplace for mobile search and native display advertising in February last year. [1] According to eMarketer, Yahoo is all set to capture over a $880 million worth of revenues from the mobile vertical in 2015, which is on par with the expected market share of Twitter (in the U.S.).

According to our view, most of the upside to Yahoo’s valuation will be from the overall improvement in Internet penetration that should boost the number of users using Yahoo’s websites and advertisers looking to monetize this base by placing more ads using the programmatic platform. Therefore, we think Yahoo is well positioned to capture a bigger chunk of programmatic spending in the future by leveraging its programmatic platform for mobile, video, and static display ads.

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Notes:
  1. Introducing Yahoo Gemini, February 19 2014, www.yahoo.com []