1) The search engine "fix" is on track for H2:06 rollout (as expected) – Yahoo! has been working on a new search platform (code name Panama) for quite some time. Per our Analyst Day preview note, we view this search engine “fix” as probably the most important R&D project for Yahoo! Among the large cap Net stocks, it’s hard to identify a catalyst as fundamentally important to a company as “fixing” its search engine is to Yahoo! During the analyst day, Tim Cadogan (VP Search) presented a detailed roadmap on Project Panama in terms of key priorities & timelines.
In terms of key priorities, Cadogan highlighted five areas: 1) launching a high performance and extensible core platform, 2) enhancing advertisers’ experience, 3) introducing an optimized market place design, 4) enhancing the consumer experience, and finally 5) expanding the breadth and depth of advertiser participation. And in terms of the timeline, Cadogan stated that the first three key priories were code complete and in testing stages, with formal launches in the U.S. on track for Q3 and Q4 and formal launches internationally on track for Q1:07. Asked what impact on monetization the new search platforms could have, CFO Sue Decker stated that the resulting improvement in RPS (revenue per search) would be a multi-year process.
While we picked up nothing to change our search revenue estimates, our takeaway here was to walk away with a more detailed understanding of the search engine “fix” timeline. And more detail is good. We continue to focus here on what should be a major positive fundamental catalyst.
2) Social search (e.g. Yahoo! Answers) provides a differentiator for Yahoo! – Jeff Weiner (SVP, Yahoo! Search and Marketplace) talked about social search and stated four global priorities for Yahoo! in social search – 1) knowledge search, 2) social bookmarking, 3) social media, and 4) monetization. Weiner disclosed that Yahoo! Answers (the U.S. product name for knowledge search) has 10MM cumulative answers and 7.2MM users as of March (up 84% from February). He also stated that Yahoo! will roll out a reputation system for Yahoo! Answers shortly.
Weiner also presented a case study that indicated that the implementation of knowledge search helped Yahoo! gain market share in Taiwan. Specifically, since the launch of knowledge search in Taiwan, Yahoo!’s share of total search page views has increased from 50% to 65%, while Google’s share has declined from approximately 45% to 30%. We found this to be a very intriguing case study with potentially very significant implications for Yahoo! (positive) and Google (negative).
But we think there are a lot of caveats to this case study: 1) we are dealing with the Taiwan market, where Yahoo! already has an extremely strong historical presence; 2) share of page views is not quite the same as share of searches, and the latter is more important given the revenue models; and 3) we haven’t seen any evidence that this feat has been replicated in any other market. But the case study is very intriguing...
Our overall takeaway here is that social search appears to provide a differentiator for Yahoo!. The open question, however, is how material or how sustainable is that differentiation.
3) Yahoo! should be able to sustain strong growth in display advertising – Presenting the company’s Global Marketing Services group were Greg Coleman (EVP, Global Advertising Sales), Wenda Harris Millard (SVP and Chief Sales Officer), Usama Fayyad (SVP and Chief Data Officer), and David Karnstedt (SVP, General Manager Direct Business). There was little new disclosure here, but there was an interesting assessment of Yahoo!’s competitive advantages based on reach, knowledge of users, advertiser experience, and graphical/search alignment. The automotive, retail, travel, and financial services verticals were singled out as continued areas of display advertising strength. And the CPG (consumer packaged goods) vertical was mentioned as a very large opportunity for the future.
Lloyd Braun (Head of Yahoo! Media Group) laid out four broad priorities for his group for 2006 – building robust platforms, developing key strategic relationships, maximizing user generated content, and building core brand extensions. The most interesting parts here were the drilldowns on Yahoo! Tech and Yahoo! Health, two of the newest content areas the company has launched. Per our Analyst Day preview note, we view these moves as part of a reenergized campaign by Yahoo! to go after high CPM (cost per impression) verticals. And based on our initial positive impressions of Yahoo! Tech, we believe this can be a successful strategy.
Display/branded advertising (approximately 30% of Yahoo!’s 2006 net revenue) has maintained approximately 35%Y/Y growth over the past three quarters. Given the Global Marketing Services group’s overall confident tone, the CPG opportunity, and the potential for greater traction with high CPM categories, we believe Yahoo! should be able to sustain strong growth in display advertising.
4)With its $1B investment in Alibaba, Yahoo! has a valuable stake in the future growth of China's Internet market - Jerry Yang (co-founder of Yahoo!) and Jack Ma and Joe Tsai (CEO and CFO ofAlibaba) presented during the Analyst Day.With the combination of its own and Yahoo!’s China properties, Alibaba now offers marketplace/payments, portal/communications, and search to the Chinese Internet market.
In terms of Internet market opportunities in China, we heard many interesting market statistics – Chinese Internet users are expected to increase from 111MM in 2005 to 159MM in 2007; B2B eCommerce increased from $17B in 2003 to $64B in 2005; consumer eCommerce GMV (gross merchandise volume) increased from $1B in 2004 to $2.4B in 2005; and finally online advertising in China is expected to increase from $287MM in 2004 to $1.37B in 2008.
In terms of Alibaba and Yahoo! China-specific datapoints, we heard thatAlibaba is now the market leader in B2B (business-to-business exchanges), online payments with its Alipay offering, and online auctions with its Taobao property. Ma also provided a 2006 revenue forecast for Alibaba of $200MM+, which translates into 100%+ Y/Y growth. We came incrementally more positive in terms of overall Internet growth opportunities in China and Yahoo!’s ability to tap into them via its investment in Alibaba. Simple point – Yahoo! has a potentially very valuable asset in China.
5) Yahoo! reiterated its 2006 guidance and laid out a framework for achieving a doubling in advertising revenue by 2008 with likely sustainable EBITDA margins in the low 40% range (largely in line with our estimates) – CFO Sue Decker provided a rapidfire overview of Yahoo!’s financial model and outlook. As expected, she reiterated the company’s 2006 guidance – $4.6-$4.9B in net revenue (up 24%-31%), a 42% EBITDA margin, $525-$625MM in capex, and $1.4-$1.6B in FCF (up 8%-19%). She also laid out a framework for how Yahoo!’s advertising revenue could double between 2005 and 2008 (we are estimating 87% growth) based on several factors including increased Yahoo! user engagement due to broadband, mobile applications, search improvements, and better products, as well as improved monetization of advertiser relationships.
On the monetization side, Decker listed two specific goals – increasing the spend from their top 200 advertisers by 2-4X and the number of non-Top 200 advertisers by 2-4X over the next few years. As one back-it-up datapoint, Decker disclosed that revenue from Yahoo!’s Top 200 clients had quadrupled over the past few years.
On the margin side, Decker described the key factors that will influence Yahoo!’s EBITDA margins in the future. On the positive side – monetization improvements from higher revenue per search [RPS], monetization improvements from better targetting capabilities, and network optimization. On the negative side – TAC (traffic acquisition costs) and distribution costs and data centers. Decker did not specifically provide a margin target. Our interpretation is that long-term EBITDA margins close to the 42% we are modeling for 2006 might be how Yahoo! plans to run its business over the next few years. We are modeling a ramp to 45% EBITDA margins in 2007. While this may be a tad aggressive relative to our margin takeaway, our revenue assumptions might be a tad conservative, leaving our overall P&L results largely in-line with the Analyst Day takeaway.
6) The underlying growth of the Internet sector remains robust – Throughout the day’s presentations, Yahoo! provided a series of datapoints on the overall health of the Internet sector. We went in with the belief that the growth in online advetising remains robust. Specifically, we are estimating a 24% CAGR for U.S. online advertising from 2005 to 2008 (and a rate closer to 30% for worldwide Net advertising over the same period). We viewed the series of datapoints as confirming our belief. We highlight below some of the more interesting datapoints we picked up:
a. Worldwide total Internet users were 1,009MM in 2005 and are expected to reach 1,750MM by 2010, a 12% CAGR;
b. Broadband penetration in the U.S. is expected to reach 70% by the end of 2006;
c. There are total of 900MM PCs worldwide and 2B cell phones, illustrating the potential importance for companies like Yahoo! to develop mobile offerings; and
d. The non-U.S. Internet user base is growing at a very fast pace – the U.S. accounted for 39% of total Internet users in 2000, 22% in 2005, and is expected to account for 16% by 2010.