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Yahoo: Still an Online Ad Play

When Yahoo! (YHOO) Chairman and Chief Executive Terry Semel announced stellar 2003 results on Jan. 14, he did his best to highlight growth across all of Yahoo's business lines -- not just advertising. After all, when Semel took over three years ago, his major goal was to diversify then-fading revenues away from pure online ad sales.

Semel didn't ignore the heady growth in online ad spending during his earnings conference call with analysts, but he tried to keep his listeners' focus on the rising number of Yahoo customers who pay for premium services such as fantasy sports leagues and enhanced financial data. That group grew from 2.2 million in 2002 to 5 million by yearend 2003. The CEO also noted growth in classified ad listings and the number of customers for broadband service bundled with Yahoo content. "We've built a strong and diverse foundation," he said, calling the fourth quarter, "the most successful quarter in the history of Yahoo!"

Sorry Terry, but there's no escaping the fact that Yahoo remains a proxy for the online advertising market -- probably now more than ever.

NOT SO BAD. Fourth-quarter revenues for the marketing services division -- where Yahoo accounts for ad revenue -- were up a stunning 60% from the previous quarter, to $393 million, or double the figure in the same quarter a year ago. Sequential growth in its revenues from fees and listings were just 7% and 3%, respectively. The advertising division contributed more than 75% of the $511 million in quarterly revenues. (All the sales figures exclude traffic acquisition costs [TAC], the fees Yahoo pays affiliates of Overture Services, which it acquired in October, 2003).

"For all of the discussion about nonadvertising businesses at Yahoo," says Derek Brown, who covers Internet stocks for Pacific Growth Equities, "investors should not lose sight of fact that advertising is what makes or breaks this company over the near, medium, and long term."

To Brown's way of thinking, Yahoo's continued dependence on online advertising is a good thing. After all, as Semel noted, total online ad revenue could grow as much as 20% in 2004, driven by such events as the summer Olympics, the Presidential election campaign, and a broader economic recovery. Yahoo could do even better than that. Semel says its ad revenue could jump 25% to 30%.

DISAPPOINTED TRADERS. "It feels like we're at the beginning of what should be a multiyear buildup" in online advertising, says Brown, who adds that his industry sources point to a Web ad market that's continuing to gain momentum after a strong 2003.

Nonetheless, Yahoo's stock, which reached a 52-week high of $50 on Jan. 12, declined in after-hours trading during the earnings call. Traders were disappointed that earnings merely met consensus expectations of $75 million, or 11 cents per share, rather than exceeding that figure. The shares slipped even though operating income jumped to $94 million, up from $55 million a year earlier.

One factor is that Yahoo's stock, which started 2003 at just $27, has gotten expensive. Brown gives it a neutral rating: "Our primary hesitancy in recommending it more aggressively is valuation," he says, noting that the shares are trading at 90 times his 2004 earnings estimate. "That seems rich to us at this point," he adds.

HEDGED BET. Still, Yahoo typically runs up prior to its earnings release and then slips back afterward. If the online ad market continues to shine, a dip could be a buying opportunity.

For its 2004 fiscal year, Yahoo projects sales (excluding TAC) in the $2.1 billion to $2.25 billion range and free cash flow of $500 million to $580 million. "$1 billion of operating cash flow is on the horizon," Chief Financial Officer Susan Decker said on the conference call following the earnings release. "The best is still yet to come."

Semel has good reason to hedge his bet on the online ad market, and he's wise to explain that Yahoo has developed other sources of revenue. But the share price remains more linked than ever to the vagaries of Internet ad spending. And fortunately for investors, that market, for now, is growing like gangbusters. By Amey Stone in New York

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