Stability Provides Platform For Potential Turnaround At Yahoo!

Yahoo! (NASDAQ:YHOO) reported third quarter earnings on the 22nd, posting net revenues (excluding traffic acquisition costs) of $1.09 billion, an increase of 2% year-over-year, and a slight increase in non-GAAP operating income which was $177 million compared to $175 million in 2011. In terms of its core revenue streams, the company’s display ad revenues ex-TAC was relatively flat during the quarter at $452 million but its search revenue ex-TAC increased 11% during to $414 million.

Since this was Mayer’s first earnings call as Yahoo!’s CEO, we were closely watching for information about her strategy to turn around the company. We did get some insights into her plans for the coming years and will examine her efforts aimed at changing the company culture and improving the firm’s core product offerings below.

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Focus on Employees

One of the primary action items for Marissa Mayer during the third quarter to implement changes in the firm’s people and culture. As first steps in the process, she sought to implement top down changes by bringing in a new CFO and COO. Additionally, to her credit, Mayer recognizes that one of the ways to foster innovation and productivity in the work environment is to be transparent and present clear cut goals to employees. This quarter she made changes to remove bureaucracy, and created a system where employees are all aware of their key objectives and goals during a quarter.

In our opinion, all of these changes can be catalysts in making Yahoo! a more transparent and innovative company. By changing the company’s culture, Mayer is likely to get more productivity out of her currently employees and create an environment which attracts top Silicon Valley talent.

Improving Execution to Capitalize On Industry Growth

Yahoo! is lucky to operate in an industry which is growing rapidly. One of the company’s primary revenue sources, display ads, is expected to post industry growth of 20% 2012. ^[1] Because the industry’s fundamentals seem to be sound, Mayer will focus on improving Yahoo!’s core competencies to match a user’s daily access habits. According to management, Yahoo!’s search, mail and mobile products are likely to be redesigned in the next few quarters in an effort to increase traffic and user engagement.

On the search front, Yahoo! will focus on better monetizing traffic and will try to increase its market share. We think that the company can leverage its existing user base to drive increases in search traffic by making it easier to conduct a search from any Yahoo! property.

In terms of its mobile strategy, the company redesigned its mobile search pages in many countries, which, according to management, has caused an increase in usage. In our opinion, this is an example of how a simple change on the mobile front can drive user engagement, and shows the potential opportunity Yahoo! has on the mobile front.

Cash from Alibaba Sale Will be Returned via Share Buybacks

A large portion of Yahoo!’s value is derived from the company’s cash and its stake in Alibaba. During the quarter, Yahoo! finalized the sale of half of its assets in Alibaba Group, and it plans to return around $3 billion of the cash it received from the sale to investors. ^[2]

During the earnings call, management announced that it would look to conduct open market repurchases of their stock to return the cash back to shareholders.  We think that this will probably be better than a cash dividend in the long term because Yahoo!’s stock is around 20% undervalued in comparison to our price estimate of $19.

Conclusion

In our opinion, the next couple of quarters are going to be decisive for Yahoo’s long-term future as they could pave the way either for a comeback or continue the slide towards internet irrelevance. From the earnings call, it seems that under Mayer’s reign, the focus will be on Yahoo!’s products. We think that given Mayer’s focus on its core businesses, Yahoo! has the potential to become a major internet force again.

Click Here to Understand What Drives a Stock at Trefis

1. Why Google Doesn’t Own the Next Chapter in Web Ads, AllThingD [↩]
2. Yahoo! Completes First Stage of Alibaba Share Repurchase Agreement Valued at $7.6 Billion, Yahoo! pressroom [↩]