•Yahoo! reiterated its 2006 revenue guidance range of $4,600MM to $4,850MM. The primary reason? Because…
• …the search algorithm fix remains a 2007 P&L event. CFO Sue Decker reiterated what management said on the 1Q06 earnings conference call: don’t expect to see any financial impact from “Project Panama” until 2007. This delay in any potential positive P&L impact from Yahoo!’s single most important R&D effort since 2002-2003 is the #1 reason why we remain on the sidelines vis-à-vis the shares.
• A dearth of detail regarding how, exactly, Panama will help Yahoo! close its technology gap with Google. Our best guess is that this was the reason YHOO shares were down 3% during the trading day and another 1% in the aftermarket. Although Yahoo!’s presentations were informative and well executed (as they always are), they lacked the kind of detail that would have had us thinking “Ahh…so that’s how they’re going to do it.” Panama will make Yahoo! search a better product for both advertisers and consumers – but in our mind that was never in question. What remains in doubt is whether Yahoo! is capable of doing more than just replicating Google’s algorithms as best it can and then throwing in some geo- and behavioral-targeting to sweeten the offering.
• Social search represents a key area where Yahoo! is ahead of Google. Yahoo! deserves credit for being more prescient than Google with regard to social search: while Yahoo! launched “Yahoo! Answers” back in late 2005, Google didn’t respond with “Google Co-Op” until last week. Why is social search important? As Jeff Weiner, Yahoo!’s SVP of Search, put it, users’ need for “ego gratification” has made user-generated content one of the fastest growing content types on the web (MySpace anyone?). Yahoo! Answers, along with del.icio.us (the biggest social bookmarking site on the Web) and Flickr (a usergenerated- image bank) are designed to leverage user-generated content and metadata to create incremental ad inventory that is more targeted and therefore more easily and profitably monetized.
• Branded advertising is Yahoo!’s biggest strength. This isn’t news, but in our mind YHOO shares will primarily remain a branded advertising play until evidence emerges that Panama is yielding incremental financial benefits for the company – investors seeking exposure to search will likely continue to look to GOOG, not YHOO. Add to this the fact that Yahoo!’s paid subscriptions business is now growing more slowly than the overall company, and branded advertising seems the only reason to get excited about the stock in the near term. We continue to believe that Yahoo!’s massive portfolio of premium graphical ad inventory and its #1 position in user traffic will drive robust growth in this segment, but at only 30% of Yahoo!’s total net revenue (our estimate) in 1Q06 it’s simply not enough to make us buyers of the shares.
• Alibaba puts Yahoo! in a position to reap the benefits of the tremendous growth in China. During the Cold War, China was often referred to as the “Sleeping Bear.” According to the inimitable and highly-entertaining Jack Ma (CEO of Alibaba), the hibernation period is over. With broadband usage in China growing at a faster rate than overall Internet user growth, 121% compounded annual growth in Chinese e-commerce since 2002, and a 47% projected 2005-08 CAGR in China’s online advertising market, it seems obvious that China is the single most important international market for U.S. Internet companies. Alibaba’s big e-commerce lead on eBay (we put Alibaba’s share at roughly 75%) remains a nice positive for Yahoo! What is less certain is whether or not Alibaba can help Yahoo! China increase its share of the Chinese online advertising market, which is currently dominated by Baidu, Sina and Sohu.
Our sense is that having a well-known, home-grown Chinese partner like Alibaba gives Yahoo! a competitive advantage over Google and eBay. And Yahoo! needs this edge: unlike Google and eBay, which both derive roughly 50% of their revenues from outside the U.S., Yahoo! currently pulls in only 25% of their revenue from abroad.
• We reiterate our 3*/Average rating on YHOO shares.