Projections of Yahoo's (YHOO) stock price depend upon a combination of factors but only a few are of key importance. On the one hand it derives 80% of its revenues from search which is a market that has grown rapidly over the past few years and is still growing at 32% per annum. On the other hand, Yahoo's revenues had been shrinking on an annual basis for several years. In short, Yahoo had been losing ground for several years.
Currently Yahoo's PE ratio is around 7.2, which is very low for the industry and for the S&P. It is at this low level mainly because the company was losing ground. If Yahoo can hold its own in terms of revenue which on the face of its December 2012 results it appears it can, its PE ratio could easily increase to around 10 fairly soon. An increase from 7.2 to 10 in PE ratio means almost a 50% increase in its stock price from its current level.
2012 saw the appointment of a new CEO, Marissa Mayer, who has now been in charge for two quarters and has deep experience of search at Google (GOOG). The quarter ended December 2012 saw Yahoo's revenues grow in nominal terms by around 10% on the previous quarter in 2012, and around 2% on the same quarter the previous year.
Yahoo derives 80% of its revenues from search and display ads. Search is a market dominated by Google, although there is a strong new challenger in Facebook (FB). According to the most recent survey by Comscore, Yahoo currently has a market share of 12.1%. According to Comscore, the search market overall has grown by 32% in recent years. If Yahoo can hold its market share, its top line should grow at the same rate.
Yahoo's market share will be determined by its ability to deliver innovative content and attract new users. During the final quarter of 2012 Yahoo signed key partnerships including those with NBC Sports and CBS Television, and launched new mobile experiences for Yahoo! Mail and Flickr.
A key direct expense for Yahoo is the amount it has to pay away whenever it derives search revenue. This expenditure arises through content agreements and agreements with Microsoft (MSFT) whom it uses to drive its search engine. The level of this direct expenditure (cost of revenue) is currently around 32% which should stay the same in 2013.
Prior to 2012, Yahoo was on a mission to cut expenses mainly by reducing headcount. During 2012 expenditure increased by only around 4%. However, if Yahoo wishes to maintain its market share it will have to innovate in order to compete. This means they well have to compete aggressively for talent and probably expand overall headcount again. Therefore, expenses, particularly in R&D, are likely to increase by around 6%.
Yahoo has typically paid income tax of approximately 33% of net profit before tax. This is quite high compared to its competitors in an industry where profit shifting to lower tax regimes is commonplace. It will be interesting to see whether the new CEO brings in some of Google's more aggressive tax minimization practices. Lowering the tax burden could hire a lot of software engineers.
If Yahoo can lower its tax rate down to 25% and increase at the same time its PE ratio to 10 to reflect its ability to hold its own in its industry, even with growth in expenses this year of 6%, the stock will increase to around $39.