Yahoo (NASDAQ:YHOO) recently announced its Q1 earnings in which it mentioned that the lower than expected search advertising results were due in part to technical limitations of Microsoft’s (NASDAQ:MSFT) search technology. [1] Last year, Yahoo partnered with Microsoft for a 10-year agreement under which Microsoft Bing will provide the search technology to Yahoo to power its search engine. Yahoo has traditionally competed with Google (NASDAQ:GOOG), AOL (NYSE:AOL) and Microsoft in search prior to the partnership.
Google is the clear market leader in search with about 68% market share. Yahoo is a distant second in this market with a market share of around 6%. Through the Microsoft deal, Yahoo gains financially as it keeps 88% of revenues generated from search ads on its website for the first five years of the contract while Microsoft absorbs most of the expenses.
Search advertising (including partner searches) constitute about 21% of our $17.28 price estimate for Yahoo stock, which is slightly ahead of the market price. In contrast, Microsoft’s Bing contributes a meager 1% to our $31.64 Microsoft price estimate, which is about 25% ahead of the market price. Together, Microsoft and Yahoo hope they can keep Google search at bay and eventually take share, which will prove a formidable challenge.
Technical Issues Behind RPS Declines
Yahoo had hoped that the partnership would bring about better revenue per search (RPS) numbers for itself. According to a study done by GroupM Search, advertisers could see cost per click to increase up to 78% above current Bing CPCs as competitors move to one combined platform with the Yahoo-Microsoft search alliance. [2] However according to Yahoo, these improvements will take longer to achieve than these studies suggest.
Here is what the management had to share regarding RPS improvements during the transition:
The good news is that many of our most important advertisers are realizing a much higher ROI on their campaign in the combined marketplace. We see major financial, auto, retail and customers spending multiples of what they spent with Yahoo! and Microsoft previously because returns have been great.
And some recent third-party reports have reinforced why we did the alliance in the first place. Advertisers CTA and ROI and Yahoo! has improved dramatically. This is good news for advertisers as they seek an alternative for their online search marketing spend.
On the downside, however, adCenter isn’t yet producing the RPS we hoped for and are confident is possible. Advertisers are seeing strong ROI, but technical limitations in the current adCenter platform mean the click volumes just isn’t there yet. We had expected RPS to be neutral by midyear, it’s now evident that it will take Microsoft longer to achieve that goal. We expect that to happen by year-end. In the meantime, the RPS guarantee helps protect our revenue and our view of the long-term potential of the marketplace remains unchanged. [1]
This goes to show that RPS improvements may not happen in the near-term as Yahoo had hoped initially. However, if this improvement happens in the long-term, Yahoo could benefit.
In a scenario where our estimated RPS remains constant at the present levels of $10 per 1,000 searches throughout the Trefis forecast period rather than declining to around $8.30 by 2013 and gradually thereafter, there could be additional upside of 10% to our price estimate for Yahoo’s stock.
See our full analysis and $17.28 price estimate for Yahoo
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