While no match for the resurgent third quarter reported by Google a few days earlier, Yahoo's (YHOO) results and its forecast for current-quarter sales beat analysts' expectations and gave further evidence that this year's swoon in Internet advertising may be ending.
Investors were pleased with the results, boosting Yahoo's shares almost 6% in extended trading after the market close. "It was a clean 'beat' quarter," says Sandeep Aggarwal, an analyst at financial services firm Collins Stewart (CLST.L). "You see signs of stabilization, which is very positive."
Yahoo, in the midst of a sweeping reorganization and rebranding campaign under CEO Carol Bartz since she joined in January, emphasized that the online advertising market is stabilizing. But still-declining revenue signaled that a full-blown recovery has yet to materialize. "Ad spending is starting to free up, and we are a great value proposition for advertisers," Yahoo Chief Financial Officer Tim Morse said on a conference call discussing the results. Bartz did not participate in the call because she had a minor illness. However, she said in a statement that Yahoo had a "solid third quarter that signals our major businesses have stabilized."
Profit from Alibaba Sale In the third quarter, Yahoo earned $186.1 million in net profit, or 13¢ a share. That's up from 4¢ a year ago. Gross revenue of $1.58 billion was down 12% from a year ago. Net revenue after commissions to advertising partners, a more closely watched metric, was $1.13 billion.
About 5¢ of the profit came from the sale of Yahoo's stake in China's Alibaba, but remaining results were still ahead of forecasts. The company was expected to earn 7¢ a share on gross revenues of $1.52 billion, or $1.12 billion after payments to advertising partners.
In particular, Yahoo saw relative strength in selling display ads on its own sites, such as its home page. Revenue from those so-called guaranteed ads, whose placement is planned in advance, grew at a mid-single-digit percentage rate. That was much better than "non-guaranteed" ads, which run on pages with less valuable audiences, such as e-mail pages. Those ads declined, partly thanks to a recent Yahoo drive to rid itself of lower-quality ads for weight loss and other schemes.
Losing Ground to Google Although display ad revenues overall grew 2% from the second quarter, the second straight quarter of sequential growth, they were still down 8% from a year earlier. Moreover, Yahoo's search business fared much worse, with search revenue falling 19% from a year earlier. That means Yahoo continues to lose ground to Google (GOOG), which saw growth accelerating in the third quarter.
Yahoo said it expects gross revenues of $1.6 billion to $1.7 billion in the fourth quarter. Operating income before depreciation, amortization, and stock-option costs is expected to be between $400 million and $450 million. Both of those are somewhat higher than Wall Street forecasts.
More than Google's results, Yahoo's may be indicative of the broader trend in online advertising, since Yahoo is a leader in the display ads that most Web sites depend on for revenue. Overall online ad revenue is expected to fall 2.9% this year but rebound to 5.9% growth next year, according to forecasts by market researcher eMarketer.
Eliminating Annoying Ads There are some other glimmers of improvement in display ads. Prices for ads sold through middlemen known as ad networks have been rising each month this year, and are up 32% since the start of the year, according to PubMatic, which helps online publishers run the most lucrative ads. "The market has bottomed," says PubMatic CEO Rajeev Goel. "Marketers are returning to the fray."
Yet the display-ad market will not bounce back as quickly as the market for search ads, the mainstay for Google, says Bryan Weiner, CEO of digital ad agency 360i. While marketers can measure the effectiveness of search-related ads through several means, including whether they result in the sale of a product, they've been less successful in testing the effectiveness of display ads other than by counting clicks, widely acknowledged to be inadequate for brand-oriented display ads.
Yahoo faces unique challenges as well. Even as it cuts some operations, it's making some costly investments in its many Web properties, as well as spending $100 million on a new branding campaign. It's also revamping its ad systems to eliminate annoying ads as well as ads advertisers pay to appear in search results. Those and other changes are expected to cost Yahoo about $60 million in revenue a quarter but eventually pay off in the form of more satisfied users and advertisers.
Losing Search Share Still, all that means lower sales and higher costs in the short term. Meantime, a deal announced July 28 to let Microsoft (MSFT) handle Yahoo's search operations likely will take until early next year to be approved by regulators. The companies estimated the deal would boost Yahoo's operating profit by $500 million annually, but it might take Yahoo a couple of years after the deal closes to reap that benefit.
Despite Yahoo's struggles since it rejected several Microsoft buyout and search deal proposals last year, its stock has risen 31%. But that's just under the Nasdaq's 32% rise—and Yahoo has underperformed the index even more than that in the nearly three months since it finally reached a search deal with Microsoft. Investors were disappointed that Bartz didn't craft a more lucrative deal with Microsoft, which did not include the multimillion-dollar up-front payment many had expected.
Moreover, Yahoo has continued to lose search share since then. Share fell by half a percentage point, to 18.8%, in September, while Google and Microsoft's Bing gained, according to market researcher comScore (SCOR). That's why some investors remain bearish. "We don't think Carol Bartz has a coherent plan for Yahoo in search," says Jeff Donlon, managing director of technology research for asset manager Manning & Napier, which holds shares in Google and Microsoft but not Yahoo.
Hoping for a Faster Turnaround Analysts, however, have turned moderately more positive on the stock of late, with 14 recommending a buy, 14 advising a hold, and only one calling for a sell, according to FactSet (FDS). Wall Street is hoping Bartz's cost-cutting and strategic focus will set up Yahoo for a faster turnaround as marketers open up their wallets starting in the fourth quarter. And if the Microsoft deal passes regulatory muster, Yahoo will not only reduce its search costs but start to get significant revenue from Redmond.