Yahoo Searchesfor Profitability

CEO Jerry Yang's ambitious turnaround plan for the Internet media company satisfied investors. But "uncertainties still exist"

Technically, Yahoo! (YHOO) co-founder turned Chief Executive Officer Jerry Yang had a full nine days left to finish the promised 100-day review of his embattled Internet media company. But Yahoo's third-quarter earnings call Oct. 16 was as much a day of reckoning for Yang as it was an update on Yahoo's financials. Analysts wanted details of Yang's plans to make Yahoo more profitable and competitive. And they wanted them now.

To his credit, Yang was ready to provide answers. During the call, Yang outlined a multiyear plan to reenergize Yahoo's profit growth that focused on making Yahoo a place where more users start their surfing experience and spend time, and a one-stop shop for advertisers looking to reach audiences across the Web. "We have defined a vision of where we want to go," said Yang. "The core is to become the starting point for the most consumers on the Internet, the must-buy for the most advertisers, and to deliver open, industry-leading platforms that attract the most developers."

Income Falling

In an effort to get audiences to start their surfing experience on Yahoo, Yang said the company would focus on Yahoo's mail client, search engine, and home page, as well as on Yahoo's most popular properties such as its leading financial and sports sites. The company plans to increase the attractiveness of these sites by enabling greater personalization—showing sports scores on the homepage to sports fans, for example—and allowing outside developers (, 9/11/07) to build programs that easily integrate with Yahoo's pages. "We intend to be flexible with our infrastructure and open up Yahoo to an ecosystem that is larger than what Yahoo can provide," said Yang.

Yahoo wants to speed innovation. Openness is a part of that, but so are recent efforts to divert resources from initiatives, such as Yahoo's paid subscription music service and entertainment properties, and toward developing new applications and services (, 10/16/07).

If anything, Yahoo's performance in the past three months underscored the need for a turnaround plan. Though Yahoo's revenues of $1.77 billion beat the high end of Yahoo's own guidance by about $460 million, Yahoo's net income fell more than $7 million from the prior year, to $151 million, or 11¢ per share.

Swelled Headcount

Investors were prepared for the news. Yahoo executives had warned analysts in July that third-quarter profits could suffer from possible advertiser cutbacks related to the credit crunch and the immediate impact of acquisitions. On the whole, The Street erred on the side of caution, anticipating earnings of just 8¢ per share. "The revenue acceleration is obviously a move in the right direction," said Goldman Sachs (GS) analyst Anthony Noto during the earnings call. "The profitability is going down."

Investors responded to Yahoo's mixed signals by bidding the stock up 10% higher in after-hours trading, to nearly $30 per share. The enthusiasm was as much a vote of confidence in Yang's plan to increase long-term profitability as it was a response to Yahoo's results this quarter. During the call, Chief Financial Officer Blake Jorgensen raised guidance for the fourth quarter, estimating that revenues, excluding traffic acquisition costs, will fall between $1.31 billion and $1.45 billion. He expects net income for the fourth quarter to be between $480 million and $550 million.

Jorgensen cautioned that margins in the fourth quarter could suffer from larger economic issues and the immediate costs of integrating acquisitions such as ad outfits Right Media and BlueLithium, as well as e-mail service Zimbra. Jorgensen said Yahoo's headcount would increase due to the acquisitions and, while future profitability would make up for the increased labor force, the company could see some immediate margin pressure. He also cautioned that, should the credit crunch and recession fears adversely impact online advertising, Yahoo could see a slowdown in spending.

Staying In-House

Despite such concerns, Yahoo executives painted an optimistic picture of the online advertising market during the earnings call. Yang said the company estimates the global online advertising opportunity is $45 billion today and will increase to $75 billion in 2010. He argued that Yahoo's decision to keep its search advertising business in house, instead of farming it out to Google (GOOG) as some analysts suggested, made it easier for Yahoo to capture a greater share of this revenue by offering advertisers a variety of options for their marketing budgets. "We are starting to see the power of combining the sales forces as well as of offering an end-to-end advertising platform," said Yang.

There are good reasons to keep search in house. Yahoo can leverage information it has from user searches to deliver targeted ads throughout its network, which has grown even larger thanks to recent acquisitions. It also wants to be able to offer the same advertiser the ability to buy direct-marketing ads—typical of search advertisements and ads targeted to user surfing behavior that are intended to lead to a sale—along with ads aimed at promoting general awareness of a brand or product with certain types of consumers. Studies from eMarketer and others have shown that advertisers see a general lift in responsiveness to their ads when they run direct-marketing campaigns in conjunction with branded campaigns, and that the top position in search results has a positive effect on brand recognition as well.

Still, analysts are cautious about Yahoo's ability to make the most of its advertising assets and become more profitable. "We expect shares to react positively, initially," says Goldman Sachs' Noto, adding, "uncertainties still exist."

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