Can Yahoo Make 'em Pay?

The Net portal's turnaround reaches a critical pass

It's a blistering August morning in Silicon Valley, and Terry S. Semel, chief executive of Yahoo! Inc. (YHOO ), sits back sipping a Diet Coke. Under Semel's leadership, the legendary Internet portal has slogged its way through a Death Valley of Web advertising, posting in July a second-quarter profit of $21.4 million. Those are Yahoo's first black numbers since the last gasp escaped from the Net bubble in late 2000. But Semel, a former top studio executive at Warner Bros. Inc., doesn't waste much breath on his rescue work at Yahoo. Instead, he focuses on the transformation ahead. Leaning forward on his elbows, Semel says: "We're going to change the way people access the Internet."

That's the linchpin of Yahoo's strategy--and could well determine whether the portal's turnaround is fleeting or just getting its legs. Within the next four weeks, Yahoo will begin selling high-speed Internet access through an exclusive partnership with SBC Communications Inc. (SBC ) SBC subscribers who sign up for the service will automatically reach the Web through a Yahoo portal. Yahoo will take a cut of the subscription fees, an average of $3 to $5 a month, predict analysts. Once broadband customers are on board, Semel plans to sell them a host of offerings, from entertainment downloads to its online personals. Add it all up, and this could generate $125 million next year for Yahoo--46% of the company's projected 2003 growth, according to WR Hambrecht & Co.

If the broadband offering is a winner, Yahoo could prove that a stand-alone Net-content company can compete in a world of media conglomerates. Such an idea long seemed far-fetched, especially after AOL acquired Time Warner in 2000 and promised to cross-sell online advertising with print and television ads--something Yahoo can't match. But AOL Time Warner Inc.'s (AOL ) struggle to stitch its offerings together lends Yahoo's simpler model renewed credence. "Yahoo's not at a disadvantage," says Kelly Corroon, e-business director at Miller Brewing Co., a big Yahoo advertiser. "We would love to see better integrated programs, but nobody has shown us one."

Still, Yahoo's broadband offering is no slam dunk. SBC spans 13 states and 37% of the territory covered by the Baby Bells. Microsoft Corp.'s MSN, by contrast, beat out Yahoo and AOL to create a partnership with Verizon Communications (VZ ). Add that to Microsoft's earlier deal with Qwest Communications International Inc. (Q ), and the software giant has 45% of the Baby Bell business tied up.

To gain greater access to customers, Semel has to create a rich high-speed channel to the Internet. Only then are other cable and phone carriers likely to ink deals with Yahoo. To entice them, Semel's planning to offer enhanced e-mail with mammoth storage capacity and a host of entertainment services. Still, rivals say Yahoo is facing a rough slog. "Yahoo's too far out from their field of expertise," says Bob Visse, director of MSN. "We've been at the [Net-access] game for seven or eight years, and a long learning curve goes into being successful."

Semel can't afford to get this wrong. So far, he has managed to prop up Yahoo's financials by cutting costs and pushing into new businesses. But these successes mask his most serious problem. Yahoo, a company built on advertising, is seeing its core business continue to shrivel. Ad sales, which account for 60% of its business, are lagging behind the rest of the market. Industry spending on such ads climbed 1% in the first-half of 2002, according to researcher CMR, yet Yahoo's ad sales tumbled 14% in the same period. "It's still too early to get excited about Yahoo's performance," says WR Hambrecht analyst Derek Brown.

Semel is undaunted. Despite Yahoo's challenges, he's on pace to meet one major goal: making half of Yahoo's money from beyond Net advertising by 2004. Non-ad revenues are expected to jump from 23% of Yahoo's total in 2001 to 41% by yearend. Semel has done this by pounding a money-making philosophy into the 3,500-person business. It has prompted everything from the acquisition of to Yahoo taking a bigger slice of transactions from its online mall. "Terry has turned Yahoo into a company that acts like adults. It's going to become a great selling mechanism," says Barry Diller, CEO of USA Interactive Inc.

This means Semel must turn more of Yahoo's passersby into paying customers. Currently, the number reaches 1 million--or 0.5% of Yahoo's 200 million quarterly users. Bolstered by broadband customers, Semel hopes to double the number of paying customers by the end of this year.

Meanwhile, he's digging deep to find non-advertising businesses. In December, he spent $436 million in a hostile bid to land recruitment site Ltd. That deal, say analysts, should add $87 million to Yahoo's revenues this year. Indeed, HotJobs, along with a new partnership with Overture Services Inc., a paid search engine, accounts for nearly all of Yahoo's growth. This year, revenues should reach $928.6 million, up 30% from $717.4 million in 2001. Last year's net loss of $92.8 million should improve to a positive $24.2 million, according to WR Hambrecht's Brown.

The trick will be to turn new deals, such as its HotJobs acquisition, into lasting breadwinners. And this will be tough. In August, the parent company of online-recruitment market leader Monster recently reduced earnings estimates, citing a weak labor market. Semel won't discuss HotJobs' performance. But according to comScore Media Metrix, HotJobs' Internet traffic has plunged by half since the start of the year, while Monster's has managed to inch up. This means that Semel, who has banked on HotJobs for much of this year's growth, could be hard-pressed to keep numbers rising next year. "Yahoo's year-over-year numbers become a bit more challenging in early 2003," says Jeetil Patel, an analyst at Deutsche Bank Alex. Brown.

Success in broadband, though, could change the mood. And if Semel's plan starts firing on all cylinders, Yahoo could regain its glitter. Bullish Piper Jaffray projects the company's sales will grow at a 30%-plus clip over the next two years, reaching $1.2 billion in 2003. That explains why its stock trades at 51 times 2003 earnings--far more than Microsoft (at 27), AOL (13), and nearly every other tech or media company.

If the broadband bid doesn't pan out, Yahoo's lofty valuation will be tough to justify. The U.S. broadband market is expected to triple, to 32 million, by 2005. So far, neither AOL nor Microsoft has gained a dominant position, which leaves an open door for the Yahoo-SBC venture.

SBC is a formidable partner with the largest digital-subscriber-line customer base among the Baby Bells. And the phone company's 3% stake in Yahoo should bolster its commitment to the deal. Already, a preliminary dial-up partnership launched by the two companies in June has boosted SBC's subscription rates 20% above its anticipated levels.

So far, it's Semel's execution that has nudged Yahoo into the black. But to turn Yahoo's short-term gains into a full-blown comeback, the ex-movie mogul needs a powerful dose of execution--and a healthy shot of good fortune. This bid to remake Yahoo is nothing less than a superproduction. And a Hollywood ending is far from assured.

By Ben Elgin in Sunnyvale, Calif.

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