Yahoo's Big Mistake

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One of the sensible reasons Yahoo! Inc.'s Chief Executive Officer Marissa Mayer gave for her $1.1 billion acquisition of Tumblr Inc. was the opportunity to target the elusive 18 to 34-year-old demographic with the company's endless web of online advertising. The financials of the deal are a little more difficult to grasp: Yahoo's revenue has stagnated over the last few years and Tumblr is still so new that it barely has any revenue at all, much less any profit.

One difficulty is that Yahoo, which generates the majority of its income through banner ads, is taking over a blogging site whose founder loves to proclaim that he hates online advertising. The bigger problem is the way Yahoo is paying for the acquisition.

Yahoo! Inc Revenue. Source: Bloomberg

The accompanying chart shows Yahoo's revenue over the last few years. As other technology companies such as Google Inc. and Microsoft Corp. introduced new products and branched out into new markets, Yahoo fell behind. The one bright spot was its 40 percent stake in China's largest e-commerce company, Alibaba Group Holdings Ltd.

In 2012, however, Yahoo agreed to sell back half its stock in a company that dominates a high-growth market in the world's fastest-growing region. The deal, which Yahoo's board approved unanimously, was worth $7 billion, of which Yahoo netted $3.65 billion after taxes and buybacks. This week, Yahoo used a chunk of that cash to buy Tumblr.

Being a pessimist about the growth of social media won't make you popular but arguing against the growth of e-commerce in Asia is a good reason to get your head examined. According to the World Bank, only 38 percent of China's 1.3 billion people had access to the Internet in 2011 -- by contrast, 78 percent of the U.S. population was online.

Of the 512 million people who accessed the Internet in China,about half engaged in some form of e-commerce, accounting for 1.26 trillion yuan ($205 billion) in exchanges. Alibaba handled almost 90 percent of those transactions. According to Morgan Stanley, the company's net income this year could surpass $2 billion -- double the total last year.

Alibaba and its sites charge a fee for every transaction they process, much like a credit-card company. Though Alibaba's dominance is far from sustainable, even in China, as more Chinese begin using the Internet its revenue will inevitably increase even as its market share drops off.

Contrast that with Tumblr, a company that has never posted a profit and operates in a crowded market that isn't particularly favorable to its business model of corporate marketing.

The company's founder, David Karp, made his direction clear when he told the Los Angeles Times in 2010, "We're pretty opposed to advertising." The problem advertisers have with social media platforms, besides the prickly high school drop-out geniuses who run them, is that these wunderkind typically have no idea how to profitably operate their creations.

Yahoo still brings in the majority of its income from those ads you see at the top, bottom or side of a webpage. Purchasing Tumblr gives Yahoo access to more eyes for its banner ads within the 18 to 34-year-old demographic -- and it gives Yahoo another platform to sell advertising on (even though Yahoo has promised not to "screw up" Tumblr with its eyesore ads).

In 2002, Yahoo could have bought Google for $5 billion. A decade later, it has sold off most of its shares in Alibaba. Ten years from now, both decisions may look equally bad.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Alex Bruns at abruns@bloomberg.net