On November 1st, Yahoo! (NASDAQ:YHOO) reached Capital Ladder Advisory Group, LLC.'s price target of $17.00 for the company, resulting in a 13% gain over nine months. Since then, the stock has appreciated rapidly; just recently hitting a new 52-week high of $20.88 per share and closing in on Capital Ladder's raised PT of $21 a share. This share appreciation and persistent attention heralded by Yahoo! has led us to reevaluate the company and determine if there are any promising investment opportunities. Capital Ladder Advisory Group's Jonathan Muller did some behind the scenes analysis of the recent developments at Yahoo! and this article details the accomplishments of Marissa Mayer and the new management team over the last two quarters respectively.
To better understand what the future holds for YHOO, we must first understand the events of the last few months that have contributed to its success. No such event was more monumental than the hiring of Marissa Mayer as CEO on July 16th. Mayer, a Stanford alumnus with an M.A. in computer science, was Google's 20th employee, and is attributed with much of the success they have had. Among other things, she is credited with designing the clean, minimalist look of Google's homepage.
Her decision to join Yahoo! as CEO has shifted Mayer's image out of the shadows of Silicon Valley into the national limelight, where she was viewed almost as a hero. One of the top news stories in July, amidst the presidential elections and Summer Olympics, was the news that Mayer was pregnant, and that her maternity leave would be "likely one to two weeks." Her image as a women's champion and a business leader grew simultaneously, with one feeding the other. Just four months after she joined Yahoo!, TIME Magazine had already selected her as a finalist for its prestigious Person of the Year award.
It is natural for the hiring of such a well-respected individual as CEO would be met with unbridled joy and enthusiasm initially, especially given Yahoo!'s previous management woes. Before Mayer, the company had five different CEOs in as many years. The last one, Scott Thompson, was relieved of his position after it was discovered that he may have embellished his academic credentials by claiming false completion of a degree in computer science.
The important question to ask is, seeing sustained levels of optimism and confidence in Mayer, has she earned this sentiment? What has she done thus far to let shareholders believe that she will be more successful than those before her? Traditionally, the President of the United States begins to be held responsible for national occurrences after his first 100 days - that's the milestone upon which tough evaluations of his leadership can take place. Mayer has been CEO for almost exactly 200 days, giving her plenty of time to implement changes and take actions that we can evaluate.
Mayer has been consistent in stating her priorities for the company. Her statement, time and time again, has been to provide ways to make a consumer's day-to-day experiences as exciting and engaging as possible. These activity areas include email, search, news, sports, finance and video primarily, with a slew of other applications and activity-supporting platforms to enhance the overall ecosystem.
Perhaps most importantly, Mayer has identified the global shift into mobile computing and has embraced it head-on, seeking to make Yahoo! as mobile-friendly as possible. During the Q3 2012 Conference Call with analysts, Mayer stated, "We haven't effectively optimized our websites, we've underinvested in our mobile front-end development and we've splintered our brands. We have more than 76 applications across Android and iOS. All of this needs to change. Our top priority is a focused, coherent, mobile strategy. We're accelerating our efforts to build a strong technical talent base for mobile. This includes engineers, product managers and designers". While her predecessors had understood the shift to mobile was taking place, they did little to move the business effectively in this direction. The means she has taken to perpetuate this shift to include the update of two new mobile apps, launched in December: Yahoo! Mail and Flickr. Yahoo! Mail is currently the most popular email service in the U.S., and the new app has been met with a strong positive reaction. Since the release of this app, Yahoo! has seen the number of monthly active mobile users increase, year-over-year, by 10%.
However, Mayer still has a non-negligible number of major obstacles she must face in order to make Yahoo! a real presence in the mobile marketplace. The Yahoo! app is still messy, convoluted, and continues to get poor reviews on both the Android and iOS platforms; they have yet to become the default search platform for any major mobile devices (Google and Bing have scores of them), and mobile ad revenue is far from showing any sort of significant growth. Mayer has repeatedly said that this transition is a multi-year goal, but in such a dynamic market, it's unclear how many years she'll have and how she intends to keep up with and ultimately surpass the competition in terms of number of users and quality of offerings.
Mayer's second major achievement has been reorganizing and revitalizing the workplace. Mayer has completely revamped her senior management team, including hiring Ken Goldman as CFO, fellow Googler Henrique de Castro as COO, and Kathy Savitt as CMO. Additionally, she has taken a series of small but extremely effective steps in increasing employee morale and recruiting more talented workers. Every employer was given a free smartphone (iPhone, Android, or Windows), to not only boost morale but familiarize all employees with the mobile platform and help bring attention to ways that Yahoo! could improve the mobile experience. She also arranged for free food to be provided throughout the Yahoo! campuses worldwide - a huge perk that rivals like Google have long prided themselves on.
As a result, Mayer reports that Yahoo! is seeing employees of all ranks improve communication significantly, increased clarity and improved execution of company-specific goals, and, perhaps most importantly for the long-term growth narrative, a swell in the amount of talent applying for various positions in the company. The more successful Yahoo! becomes at optimizing these communications and recruiting employees of the same talent and caliber as Google, Apple or Facebook, the more successful they will be at generating the revenue and keeping pace with (and hopefully eventually leading) market innovation.
Mayer's contributions aside, Yahoo!'s business model has always covered a very wide scope and has given the company plenty of opportunities to leverage its services and create new revenue-generating opportunities. In the last conference call, Mayer stated she identified twelve key Yahoo services which she is targeting to improve and expand upon. While she refused to list all of them, we can conclude that among those twelve are most of Yahoo's core offerings. These include email, home, news, finance, sports, search, IntoNow and Flickr; the other five probably include some of Yahoo's shopping services, messenger, and entertainment.
Mail and Flickr were already discussed, but the other offerings are just as popular. Yahoo! streamed over 1.9 billion minutes of coverage of the US elections, making it the most watched live-stream event in the company's history, and providing a lucrative additional revenue stream in the form of video advertisements. Yahoo!'s omg! entertainment news service is now being broadcasted to millions of home viewers with six primetime airings each week.
One of Yahoo!'s most promising platforms to assist it in becoming a dominant entertainment presence is IntoNow, a small app Yahoo! acquired two years ago for about $25 million. The app, available for both iOS and Android, uses the phone's microphone to determine what TV show you're watching, whether it's an old episode being streamed online or live content. The app then checks you into the show, much like Foursquare, and connects you with your friends on Facebook, Twitter and other social media sites that have seen or are watching the same programming. The newest update to IntoNow even identifies songs being played in shows and stores frames of every show aired in the last week, allowing you to share photos of memorable or eventful moments, and even make themes out of them.
IntoNow's promise was certainly seen early on - just a few months after its release, it was TIME's "Best Smartphone App of 2011" award. Unfortunately, it has not yet picked up the user base it needs to be a viable revenue stream; the most recent update has less than one million installations from the Android Market. Regardless, it has huge potential to greatly bolster the company's earnings once that mass is attained, by offering sponsored show recommendations, advertising merchandise of watched shows, or even being able to identify commercials being aired and giving users more information about that product. And, while competition is arising in the form of GetGlue, Viggle and Zeebox, the explosive growth in the social TV market indicates that such apps will become increasingly popular over time.
A large reason for this continued success, and an opportunity for continued earnings, comes from Yahoo!'s very well-developed network of partnerships. Yahoo! News has formed an alliance with ABC news to provide more in-depth broadcast to Yahoo!'s large news audience. Notice at the bottom of the linked homepage, you will see the declaration referring to the partnership between ABC news and Yahoo!. Additionally, omg! is being aired almost daily thanks to a partnership with CBS's The Insider, changing the name of the programming to omg! Insider.
The largest of these partnerships stem from search. During the time of the Q4 report, Yahoo! had a search-sharing deal with AOL and Microsoft. The deal allowed each company to host another firm's ads on its own website, thus increasing the ad experience for users and allowing each company to make use of unsold or non-guaranteed ad space. For a while it looked like a strategic partnership aimed at lessening Google's dominance in the search ad space, while allowing each search provider to ensure some level of ad search related success.
Yet, on February 7th, Yahoo! announced a similar partnership with none other than Google. The deal will allow Google to display ads on Yahoo! properties. The huge upside to this is that it allows Yahoo! the chance to attract more advertisers as clients, assuming they see benefits from having ads displayed on Yahoo! It is also a potentially lucrative deal on its own - while neither company disclosed the distribution of sales, previous comments made by Google for similar deals indicate that Yahoo! may keep 68% of revenues generated.
Perhaps the biggest concern for the company is that, in spite of an arsenal of innovative and powerful apps and features, the core of the business doesn't reflect that level of dominance. Display and search advertising, the company's bread and butter, seems to be more bread and less butter with each quarter. While Google made over $12 billion in advertising alone in the fourth quarter, Yahoo! didn't even generate $1 billion. The reason for this is simple; Google's dominance in search is continuously solidifying, making it harder for competitors like Yahoo! to get a foothold in the market. The solution, unfortunately, is more complex. Yahoo! seems to be approaching this problem by converting users through its additional apps; they hope people will go to Yahoo! for finance or entertainment and stay for search. While the idea is a good one and could work quite well, it will only do so if search marketing and improvement efforts are raised to the same level as other Yahoo! products. Search looks messy and crowded, and it returns way more results than Google, but those results are less targeted, and thus less useful.
The benefit is that, with search in such a weak state, any significant boost could send the company's stock price skyrocketing. Yahoo! has a market cap of almost $25 billion; however, it has almost $20 billion in cash and equity in Alibaba and Yahoo Japan. The conclusion that must follow is that the value of the company itself is highly discounted as Yahoo! for many years has been losing revenues and users, only to start reversing that trend now. Upgrading its search features and marketing the service more prominently present the single biggest opportunity for both top and bottom line growth.
Over the last six months, things seem to have been going pretty well for the company. While the pattern of success is far from realized, the trajectory of the company certainly looks much better than it did even one year ago. However, along with the rise in the prospects of the company came a rise in its share price. The real question is whether or not this increase has accounted for the entire rise in value. A look at Google Finance, Reuters, and others report that shares are trading at a bargain 6.2 P/E ratio. However, this is a gross inaccuracy as it includes the $2.8 billion post-tax revenue received from the third quarter sale of half of the company's stake in Alibaba. Taking this out of consideration by annualizing Yahoo!'s most recent quarter, the stock trades at a P/E ratio of about 20, in line with the sector average. In the last quarter, revenues grew 2% YoY, but operating and net income actually fell due to an increase in traffic acquisition costs. In spite of that, Yahoo! managed to record its first year of growth in four years, which certainly helps fuel investor optimism.
Further evaluation of earnings in the past two quarters provides further mixed feelings. While revenues grew in both quarters on a YoY basis, the company has seen an actual decrease in sales in both its Europe/Middle East/Africa (EMEA) and Asia-Pacific (APAC) regions. Growth in the Americas has helped offset this, but the Americas also represent the company's largest and most developed market. Additionally, search revenues have grown both quarters. In the past year, the number of paid clicks has grown by 11%, giving us surprising evidence that Yahoo! is regaining its hold in the PC market. However, even more surprising is that display ads, the main type of ad for mobile platforms, has seen earnings decline, as the number of display ads sold has actually decreased by 10%. From a financial perspective, Yahoo! managed to protect from these losses by partially offsetting them with an advertising partnership with Microsoft that allows the companies to use one another's unsold and uncommitted ad space for a price. However, it certainly raises concerns about Yahoo's ability to generate enough mobile traffic to be an appealing marketing medium for companies, and their ability to monetize the millions of active users they already have.
While the company's earnings metrics present convincing metrics for both optimism and pessimism, Yahoo!'s balance sheet is pristine, and leaves investors with a decidedly bullish sentiment. As of the end of Q3, Yahoo! had over $7.5 billion in cash, and $9.7 billion in current assets, representing 31% and 40% of the company's market cap, respectively. The amount of cash grew by $6 billion over the course of the quarter thanks to the Alibaba sale, and the company still holds a 24% stake in Alibaba, which plans to go public at some point in the last three years. The remaining position in Alibaba is valued at $8.1 billion, not including an additional $800 million in preferred shares. Additionally, Yahoo!'s holding in Yahoo Japan as of the end of the quarter was worth an additional $6.6 billion.
While the company has a full $17 billion in assets, they face only $2.5 billion in total liabilities. As a result, shares are trading at an enviable 1.6 times book value. For the sake of comparison, Google trades at 3.5 times book value, Microsoft trades at 3.5, and Facebook trades at 5.8 times book value.
Additionally, the company is committed to returning capital to its shareholders. Mayer had announced in the past that all proceeds of the Alibaba sale would be returned to shareholders. In Q4, Yahoo! had already spent $1.5 billion of those funds buying roughly 80 million YHOO shares. Since the company doesn't give dividends and has already effectively utilized its buyback strategy, it's safe to assume the remaining $1.5 billion or so will be spent the same way - through share buybacks, as opposed to initiating a dividend or even issuing a special dividend as some had hoped.