Yahoo in Crisis Despite Potential 3-Way Ad Deal AOL and Microsoft

The speculated deal of Yahoo (NASDAQ:YHOO), AOL (NYSE:AOL) and Microsoft (NASDAQ:MSFT) selling each others ad inventory might provide some respite for the companies’ struggling ad businesses by reducing traffic acquisition costs (TAC). However, we believe this would be a quick-fix solution and given that AOL and Yahoo’s general content businesses are struggling severely, we don’t think this will have much of an impact on Google (NASDAQ:GOOG) and Facebook’s booming online advertising revenues or will it solve Yahoo or AOL’s problems longer term.

We currently have a price estimate of $17 for Yahoo’s stock, which is about 13% above the current market price. Display advertising constitutes about 22% of our price estimate.

Selling Excess Ad Inventory Should Reduce TAC

While still speculative, the deal involves the 3 companies selling their “Class 2 Display” ad inventory. ^[1] These are advertisements which were not able to sell themselves, and hence handed over to ad networks on which Yahoo, AOL and Microsoft incurred traffic acquisition costs (TAC). If the companies are able to sell these ads themselves, there can be an upside to Yahoo’s net display ad revenues, which is basically gross revenues less TAC.

This Looks Like a Band-Aid for Now

While Yahoo might see some improvement in gross profits, this does not take away from the fact that the company is languishing due to the nature of its business itself, whose purely web-based content is losing out to today’s mega-trends of social networking, smartphones and tablets. See our note on the prospective AOL-Yahoo merger in our note titled AOL-Yahoo Merger? Two Struggling Businesses Can’t Rescue Each Other.

Given Carol Bartz’s departure and the fact that private equity funds are in discussions about making a bid for Yahoo, we understand why Yahoo might want to pull any existing levers it has to improve its financial position; however, we believe to remain competitive it will need to a more serious overhaul of its operations. ^[2]

See our full analysis for Yahoo

1. Forbes: Yahoo, AOL, Microsoft plan ad sale deal [↩]
2. Bloomberg: Silver Lake Is Said to Weigh Buying Yahoo [↩]