* Yahoo! had its analyst day yesterday, at which the company outlined its long-term business initiatives and goals. We continue to rate shares of YHOO Buy and have adjusted our target price to $39 to reflect slowing rates of industry revenue growth, a rising competitive landscape driving higher capital costs, and a changing macro backdrop limiting consumer discretionary spending. Our target price equates to an enterprise value of $39 billion after netting out a discounted value of Yahoo! Japan, net cash, and the NPV of Yahoo!'s NOL. On an EV/ unlevered, taxed FCF basis, our target valuation equates to 40x our 2007 estimate. We find Yahoo! to be a compelling long-term-oriented investment for investors interested in access to the advertising distribution shift toward the Internet that we expect to continue for the foreseeable future. In 2005, we thought investors were pricing in too much of the advertising shift into the valuations of Internet advertising stocks; we now believe the share pullbacks in the sector offers opportunity.
* We continue to focus on the 4% of advertising dollars spent on the Internet compared to the 15% of discretionary time spent on the Internet by consumers. Advertising dollars lag time spent but eventually advertisers find consumers and given the proliferation of mobile access, wifi networks, improved content, better query results, and access to video in a searchable format on the Internet, we believe the 15% figure is just the beginning. Before the emergence of the Internet, traditional media companies with similar competitive positions in the offline world were afforded peak valuations well above Yahoo!'s existing capitalization.
* As summarized below, Yahoo!'s management team discussed international growth as an industry driver, entering the depth phase while focusing less on breadth of products, the proliferation of mobile devices expected to be more than double the installed base of PCs by 2008, improved search monetization as a 2007 benefit, a global ad opportunity growing from $24 billion in 2005 to $55 billion in 2010, advertisers focusing on consideration and engagement rather than the previous awareness and purchase, and a platform that touches roughly 50% of the 1 billion global internet users on a monthly basis.
* There were no changes to financial guidance although the company did offer some detail on when search monetization becomes relevant to the income statement. Specifically, the platform is in testing phase and will launch in the U.S in 3Q06 and international in 1Q07, the advertiser experience is in testing phase and will launch in the U.S. in 3Q06 and international in 1Q07, the marketplace design will launch in the U.S in 4Q06 and international in 1Q07, and the consumer experience and advertising participation are ongoing. Given the timeline on the search monetization improvements, we expect Yahoo!'s 2006 results to be within the range set by management but do not expect the potential for outperformance to our estimates until 2007.
Internet Growth and Reach: According to management, user growth is likely to continue at a double-digit rate with worldwide penetration to expand from about 1 billion Internet users in 2005 to about 1.8 billion in 2010, or a CAGR of 12%.
Shift in Geographic Distribution: In 2000, North America accounted for about 39% of all Internet users. It is estimated that by 2010, the percentage will decline to 16%. Concurrently, parts of Asia Pacific (including India, China, and excluding Japan) are expected to see worldwide user base go from 17% in 2000 to about 36% in 2010.
Media Growth Rate: Yahoo! presented estimated growth rates of time spent online by individuals. U.S. media growth rates from 2005 – 2009 show the Internet growing a robust 10%, cable/satellite growing 1%, broadcast and box office flat, and newspapers shrinking by 10%. Driving much of this growth is the deeper engagement that the Internet affords, specifically through broadband, mobility and search.
Deeper Engagement: Estimated broadband penetration is expected to grow from 136 million households in 2004 to 312 million households in 2008. Currently, only 18% of the world uses broadband, according to Yahoo!'s management. Further, management estimates that by the end of 2006, broadband penetration in the U.S. could possibly reach as high as 70%. As for mobility, there are 900 million PCs in the world, and over 2 billion cell phones, allowing for a wide audience for reach.
Advertising Opportunity: The global advertising market is expected to see an 18% CAGR between 2005 and 2010, growing to about $55 billion in 2010. Yahoo! benefits from its extensive reach to consumers. According to management figures, 1 in 2 Internet users is using at least one Yahoo! site each month. Further, there are currently 6 million Yahoo! groups with cumulative members of 90 million. This affords advertisers relevant audiences and allows Yahoo! to better monetize its products.
Platforms: Yahoo! envisions going "beyond the browser" for a seamless and personalized user experience across all devices, including mobile. As such, the company is looking to create competitive advantages in media (with an end-to-end publishing solution), advertising (with addition distribution options and audience targeting), data (enhancing ad sales and allowing greater engagement), community (network effects), personalization (relevant content generation), and communications (increasing distribution).
Future Opportunities: The "next" Yahoo!, as management referred to it, will incorporate greater user experiences focusing on products, users and advertisers, and by blazing a new trail in media and social search. These should enhance future monetization opportunities by providing a rich graphical experience, better targeting through monetization and further engagement (click to call, buy, search for more, follow-up email).
Yahoo!'s Opportunity: The Internet is outpacing traditional media with content as the fastest-growing sector online. Much of the growth is attributable to broadband acceptance. Yahoo! currently has about a 70% global search reach with more than 700 million search users per month. Yahoo! estimates that there will be an approximate $15 billion global paid search market for 2006, with a 30% expected CAGR between 2005 and 2008.
Global Priorities: These include knowledge search, social bookmarking, social media and monetization. Yahoo! believes the company can create greater depth by leveraging its base of human knowledge to expand the global repository. Through first-mover advantage, Yahoo! believes that the company can achieve critical mass in knowledge search by building network effects through high-quality content and broad distribution. Yahoo! Answers reached 7.2 million users in April 2006 and has generated over 10 million answers to date. Further, social bookmarking (the ability to share your bookmarks) can offer a greater level of personalization by leveraging contacts and trusted community sources. Management believes the company can generate additional monetization abilities by developing new revenue streams from user-generated content and by growing inventory.
Search priorities: Management is looking to: (1) launch a high-performing core platform that incorporates performance, scale and rapid innovation, (2) enhance the advertiser experience through greater ease of use, better effectiveness, more action focused for bidding and budgeting, and more rapid innovation, (3) introduce optimized marketplace design through consumer sponsored search quality, incentive alignment and advertiser control and transparency, (4) continue to improve the consumer-experience through a new ranking algorithm and enhanced geo-targeting, and (5) focus on the breadth and depth of advertiser participation. In terms of launch timing, the new platform and advertiser experience enhancement is in its testing phase and should launch in 3Q in the U.S., marketplace design enhancement should launch in 4Q, while the changes to consumer experience and advertiser participation are in ongoing iteration. Management noted that it does not expect to see a financial contribution in 2006, but are looking more toward 2007.
Alibaba and China Opportunity: According to management, there are over 23 million SMEs in China, which account for 50% of the country's' GDP. Over 700,000 have their own Web sites. Alibaba is the fourth-largest Chinese Internet company, with 2006 forecasted revenues above $200 million or over 100% year/year revenue growth. Broadband usage is escalating with a 55% estimated CAGR between 2003 and 2007. There is also an increasing adoption toward conducting business online, with B2B ecommerce trade increasing 93% [CAGR] from 2003 to 2005. The online advertising market in China is expected to grow to almost $1.4 billion by 2008. Alibaba is positioned to take advantage of this growth as most publicly traded companies in that country are involved in wireless services or games. Alibaba has seen an increase in revenues per customer as revenue CAGR has grown 162% from 2002 to 2005 while paying customers have seen a CAGR of 121% over the same time period.
Growth: Yahoo!'s management see two main sources of growth: volume and monetization, through both supply (increase number of users and get more revenue per user) and demand (increase number of advertisers and generate more revenue per advertiser). Management expects to see even greater growth in ARPU. While Internet users in North America are only supposed to grow 6% between 2005 and 2010, on a global basis, user growth is expected to be closer to 15%. Relative to the industry mix, Yahoo! is more heavily weighted in the Asia Pacific region. Key drivers of usage depth will be mobile adoption, broadband, search and better products. Currently, communications and content are the largest categories in terms of share of time spent for users.
The Internet makes up about $80 billion, with advertising expected to account for $31 billion in 2006 and commerce expected to account for $48 billion. Global online advertising is expected to increase $15 billion in the next 2 years. Yahoo! is in a position to benefit from this trend.
Outlook and Trends: Looking forward, monetization is likely to be increasingly important, with Yahoo!'s marketing revenue potential to double or more over time. For 2006, Yahoo!'s outlook implies stable margins in the low 40% area. Margins have begun to stabilize after a rapid ramp. Management noted that they would continue to pursue a thoughtful acquisition strategy. Management reiterated guidance for free cash flow between $1.4 billion and $1.55 billion for 2006, with revenue ex-TAC of between $4.6 billion and $4.85 billion. YTD share repurchases are close to $1 billion.