By Jane Black If one company deserves credit for the Internet ad revival of 2003, it's Overture. In 2000 and 2001, when the market was at its nadir, ad network Overture (OVER) aggressively built a marketplace of pay-for-performance placement on search-engine result pages. The theory: People who were actively looking for something would be more likely to respond to ads for relevant products and buy.
The proof is in the clicking. Today, paid search accounts for 33% of $6.6 billion in online ad revenues, up from just 7% in 2001 (see BW, 5/2/02, "Online Ads Take Off -- Again"). In 2003, Overture expects its revenues to skyrocket to more than $1 billion, up from $667 million in 2002 -- one of the key factors that landed it at No. 68 on BusinessWeek's 2003 Info Tech 100 list.
WHERE IT HURTS. Overture, formerly Goto.com, is without doubt one of the Web's great success stories. But will it become a victim of that success? The fat pay-off in paid search has lured some of the Net's most powerful players to the market -- including search giant Google. And competition is hitting Overture where it hurts. Cutthroat pricing has sliced margins at exactly the time Overture has been forced to make investments in new technology to broaden its reach.
Though revenues will grow 54% in 2003, earnings are expected to tumble 74%, from $1.29 per share in 2002 to just 34 cents in 2003, according to a consensus from First Call. Since January, the stock has tumbled from a high of $31.30 to $16.32 as of June 10 -- a still pricey valuation according to most analysts.
To boost margins -- and compete with Google -- Overture must transform itself from a pioneering ad network into a technology company with a range of services. When the paid-search business was new, Overture could afford to stick to that one valuable service. Today, it must provide that as well as unpaid search results to partner Web sites, most of whom see Google as the gold standard for relevant results (see BW Online, 6/10/03, "The Web, According to Google").
"WE'RE EVOLVING." To that end, Overture acquired search-engine AltaVista and the Web-search division of Norwegian search company FAST in February for $140 million. The plan: To become a one-stop shop for search results. The move came eight months after AOL (AOL) switched from Overture to Google for its Web-scouring needs.
"There's no doubt we're evolving as a company," says Ted Meisel, Overture's president and CEO. "As the market has matured, some partners have demonstrated that they would rather work with one supplier."
In the next 60 days, Overture also plans to roll out a new content-targeting service, which will put its technology to work for Web publishers. Soon, instead of getting paid ads only on search-engine result pages, Overture's technology will "read" news articles and home pages on clients' sites and dynamically place relevant ads. So, if you're reading a story about broadband, you might see an ad for discounted high-speed Internet service. Google already has a similar system up and running.
"SINKING TIDE." Yet Overture faces some daunting challenges in the coming months. In the red-hot Net-search market -- which analysts project will be worth more than $6 billion by 2007 -- the sands can shift suddenly. In 2001, Overture owned the paid search market. By the end of 2002, Google was serving ads on 50% of the total search-result pages served each month. (The coup was made simple by the fact that Google itself receives 35% of the hits on its own popular search site, Google.com, according to Nielsen NetRatings.)
"Momentum will run against Overture for the next few quarters before the company's current actions might start to reverse the sinking tide," Citigroup Smith Barney analyst Lanny Baker wrote in a May 9 research report.
Those actions include doing everything in its power to keep its two marquee clients, Yahoo! (YHOO) and MSN (MSFT), which together account for 64% of Overture's revenues. Under the current deals, analysts say, Yahoo and MSN take as much as 70% of every dollar earned. And though that revenue has boosted both partners' bottom lines -- in 2002, Overture delivered Yahoo more than $130 million in revenues, or 14% of its total business -- speculation is rife that one or both of the tech giants might build a competing system rather than continue handing over 30% to Overture.
TOO THIN A SLICE? Yahoo has already taken steps to reduce its reliance on outside search providers. In December, 2002, it bought Inktomi, a search technology company. And in January, it hired away a top Overture executive, Tim Cadogan, to run its search division, raising speculation that it might try to replicate Overture's system in-house. Overture has two deals with MSN, one is up in December, 2003, the other in December, 2004. Yahoo's contract expires in April, 2005.
Even with smaller partners -- and that's most of the online ad universe -- Overture faces steep pressure on margins. With Google in the game, Overture has to offer all of its distribution partners a bigger share of the revenues to persuade them to sign. Traffic-acquisition costs, or TAC as they're known, increased from 53% of revenue in the first quarter of 2002 to 64% in the first quarter of 2003.
These costs will keep Overture's operating margin hovering at around 5% -- even at $1 billion in revenue. According to Citigroup's Baker, Overture will have to bring in $1.7 billion in revenue before margins reach the 10% range.
A FOIL TO GOOGLE? Advertisers and more than a few analysts are confident that it can make the transition. "They've always scaled their business really well. They've earned our trust by coming through on every promise they make," says Jeff Lanctot, vice-president of interactive ad agency Avenue A (AQNT), one of Overture's largest partners.
As for Yahoo and MSN, many analysts believe it's in their interest to keep Overture a healthy, if only as a foil to Google. In the search business, market share matters. If Yahoo and MSN were to build in-house solutions, they would hold only 20% and 15% of the market respectively -- leaving the lion's share to archrival Google.
The same logic applies to rumors that Yahoo or MSN might buy Overture: Without its independence, Overture's value diminishes. "There's a very healthy tension in the market today," says Christa Sober, an Internet analyst at Thomas Weisel Partners. "It's in Yahoo's and MSN's interest to keep it that way."
OTHER PASTURES. And there are still foreign markets to conquer. "It's foolish for everyone to say it's done, tied up, and finished," adds Danny Sullivan, editor of Searchenginewatch.com, a Web site that tracks the industry. According to Sullivan, who is based in Salisbury, Britain, Western Europe is about two years behind the U.S. market, which gives Overture ample opportunity to extend its network of partners.
Plus, future technological advances, reaped from recent investments, could push Overture back into first place. Yet, even Sullivan admits the next few quarters will be crucial in determining whether Overture gets its encore. Until then, cautious investors will likely hold their applause. Black covers technology for BusinessWeek Online in New York