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Investors were willing to look past a report showing that Yahoo's sales growth slowed in the third quarter. They were even willing to forgive a forecast for fourth-quarter sales that will miss analysts' predictions.

What they were really after was news on a project Yahoo! (YHOO) calls Panama, and on that score, Yahoo didn't disappoint. Project Panama is designed to improve the way Yahoo matches advertisements to the subject of search queries—a move that could translate to higher sales—and it hit snags earlier this year.

But on Oct. 17, when the company released third-quarter results, Yahoo said the project has finally gotten off the ground. Phew. In extended trading, Yahoo stock rose almost 3%, to $24.83.

TARGETED QUESTIONS Investors were eager for some good news from Yahoo. The company had said in September that third-quarter earnings would come in at the low end of its forecast range due to softening in financial and automotive advertising (see, 9/21/06, "Yahoo's Ad Slump"). It reported revenues, excluding traffic acquisition costs, of $1.12 billion for the third quarter, a 20% increase over 2005. That was in line with Wall Street's average estimate of $1.14 billion and on target with the bottom end of the $1.12 billion to $1.23 billion Yahoo initially expected.

During a conference call with analysts, Yahoo said fourth-quarter revenue would be $1.15 billion to $1.27 billion. Wall Street was banking on $1.31 billion. Says Caris & Co. analyst Tim Boyd: "They did disappoint more than the estimates said. People are going to want to know what happened."

What happened: Advertisers increasingly want targeted advertising, which tailors ad placement more specifically to users' habits. Yahoo has lacked a highly targeted advertising platform, making it vulnerable to a slowdown in the economy that has yet to affect, and may never affect, main competitor Google (GOOG). In an Oct. 17 note to investors, Cowen & Co. analyst Jim Friedland wrote that advertisers are more likely to cut back on general display ads when sales are tight than to reduce targeted ads that are more likely to generate sales. Yahoo relies on display advertising for about 40% of its revenue. "We believe [Yahoo] is more exposed to an economic slowdown than Google," Friedland wrote.

THREE-PRONGED PLAN Yahoo is also suffering from more competition from new social-networking sites that provide both cheaper advertising platforms and desirable young audiences. News Corp.'s (NWS) MySpace, Google's recently acquired YouTube, and Facebook all are giving Yahoo a run for its money (see, 10/16/06, "High Hopes Abound for High Tech").

During the conference call, Yahoo CEO Terry Semel acknowledged that the company needs to provide more targeted advertising and said that it is confident Panama will have the necessary results. "I am not satisfied with our current financial performance, and we intend to improve it," Semel said. "We are not exploiting our considerable strengths as well as we could be, and we are committed to doing better."

Semel outlined a three-pronged plan to improve Yahoo's revenues. The company's first objective, Semel said, is to close the gap with Google in its ability to make money off of search advertising. In addition to Panama, the company announced two new relationships with advertising technology companies that should further that goal. Yahoo acquired AdInterax, a provider of rich media advertising tools, for an undisclosed sum.

BANNER LEADER It also purchased a 20% stake in the Right Media Exchange, a company that allows advertisers to bid in real time on ad impressions. Using Right Media, an advertiser can bid to place ads on pages that are about a particular subject, such as music, or on pages with certain words. The advertisers who offer the highest price for pages with those particular criteria have their ads placed on the page until the moment they are outbid. Once they are outbid, at any point in the day, the ad on those pages changes to the new winner's ads.

Mike Walrath, CEO and founder of Right Media, said that the relationship will add value for Yahoo's advertisers, who can use the technology, and also enable Yahoo to make money off pages for which its own sales force does not yet aggressively negotiate ad prices. "Yahoo is going to be able to monetize that page and say who is the highest bidder," says Walrath.

Yahoo's second objective is to continue to provide graphical advertising such as banner ads. Semel said that the company will continue to invest in that arena to remain the leader in the space and widen the gap with newer advertising platforms, such as MySpace.

ROAMING EYES Yahoo also plans to continue to focus on and invest in social media. "We are convinced that the social media space will continue to grow and evolve, and we plan to be a key player in this business," said Semel, adding that Yahoo has grown Flickr,, and Yahoo Answers, which currently have 30 million users between the advertiser-coveted ages of 15 and 24. Semel did not specifically mention social-networking site Facebook, which Yahoo is rumored to be trying to acquire (see, 9/22/06, "Yahoo Keeps Its Eyes on Facebook").

In the future, Semel said Yahoo will also focus on bringing more of its products to mobile phones in hopes of capitalizing on Internet users in emerging markets whose first experience with the Web may be through a telephone or similar portable device. "Eighty percent of users in emerging markets are going through mobile devices to get to the Internet, and that to us is such a large market," says Semel.

Whether foreign markets and Yahoo's other initiatives will bring Yahoo the kind of growth the industry has come to expect from Google remains to be seen.

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