It's typical when you are searching for something on the internet to just "Google it" because the Google search engine has become such a commonality in our lives. But for those of you following the story, Yahoo (YHOO) has been making a huge push to replace Google as the new search engine of the future. Since the new CEO Marissa Mayer took over last summer, the stock has risen about 70%. But before we hand Mayer the "CEO of the year" award, it is important to note that much of this growth in stock price is attributable to stock buybacks and the growing value of Yahoo's Asian assets. Having said that, Mayer has been busy improving the company's image by enhancing employee involvement, purchasing world-class assets, and making other important changes to the company's image. Most recently, Yahoo announced that it has agreed to acquire Tumblr-a social media/content sharing website. This article analyses the short-term and long-term investment opportunities for Yahoo following the Tumblr acquisition.
Scope - How big is the opportunity? How large is the downside risk?
Tumblr is a 6-year-old company with 184 million unique visitors, and 12.1 billion page views last month according to Quantcast. The opportunity for Yahoo to benefit from this powerfully engaged and creative user base is tremendous. Unlike the acqui-hire of Summly-whose founder Nick D'Aloisio is still in high school-Yahoo is acquiring a smart, engaged, and truly visionary leader from Tumblr-David Karp. According to Forbes, Yahoo needs Karp's passion for content and community, and Mayer is committed to letting him focus on users and products rather than revenues. That's a good thing for Tumblr, Yahoo, and investors and staffs of both teams.
On the other hand, critics will remind you that Yahoo has a terrible track record with acquisitions (i.e. Flickr and Geocities) and speculate that the Tumblr acquisition will likely head south. This deal will not make any sense to me if Yahoo (and Mayer) takes away autonomy from Karp to grow his brand since a huge determinant of success for this 4 year deal is based on user growth. Speculators immediately point to Yahoo's law division potentially shutting down a heap of Tumblr pages for copyright infringement as well as a significant number of porn pages on Tumblr. If this happens, we can throw Flickr and Tumblr into the same basket of "failing start-ups without an 'e' at the end".
That being said, I believe the upside far outweighs the downside as Yahoo has already signaled its intention of leaving Karp alone. Mayer can only hope that Karp will get the job done right.
Potential upside: (+29.6%) $35 price target
Potential downside: (-18.5%) $22 price target
Context - Why does this opportunity exist?
Yahoo under Marissa Mayer isn't the same old Yahoo that we're accustomed to and the recent acquisition of Tumblr is her best investment since starting as CEO of the company. As mentioned earlier, there is an immense opportunity for Yahoo to benefit from Tumblr's user base.
At the core, Yahoo is acquiring, with its idle cash, over 300 million young, mobile users. Big tech companies (i.e. Google (GOOG) and Apple (APPL)) tend not to know what to do with its huge cash account. As a result, the cash sits there doing nothing for the company. Mayer's decision to have $4.4 billion in cash plus Tumblr is far superior to having $5.5 billion in cash. Other immediate benefits to the company include:
1. An immediate traffic boost
2. Acquisition of invaluable information about what Tumblr users consume online and the frequency of this consumption
3. Synergies to the rest of Yahoo's pages (i.e. replacing a one-size-fits-all generic home page to a dynamic page that changes depending on what users view on their Tumblr accounts)
4. Enhancement of Flickr's home page, photo page, and photo stream page
Catalyst - What will drive a change in investor perception and share price
With a new management team and renewed focus on products, I believe Yahoo has the potential to become a classic "turnaround story". Mayer has gone on a shopping spree as of late but hasn't produced any visible signs of improvement for the company. Not to mention, some of the deals (in particular Flickr) has underperformed to say the least. This turnaround will likely be a multi-year effort, and further product improvements are required to drive the stock even further and give investors confidence in the company's ability to improve the Search and Display segments (something the company has struggled with for a five-year period). Furthermore, a lack of EBITDA growth for the past 6 years has really hurt the company.
Upside catalyst: Continue to execute on its new product focus (including its search partnership with Microsoft), and improve both user engagement and Display segment.
Downside catalyst: Act like the new sheriff in town and take autonomy away from start-ups (i.e. Flickr and Tumblr) and failure to execute on its new product focus.
Timeframe - Is this a multi-year play or a short-term opportunity?
Yahoo is the largest consumer portal in the world with 325 million users worldwide and is benefiting greatly from its appreciating Asian assets. In the short-term, I predict revenue headwinds due to the expiration of the Microsoft "Revenue Per Search" (RPS) guarantee. This, coupled with stagnant EBITDA margins, will drag the stock prices down to a range of $22 to $24 per share. In the long-run, however, I believe Yahoo has the potential to become a class turnaround story. To put a number on that, its common stock can reach the $35 level if Mayer can increase web traffic and improve mobile engagement. Whether Yahoo can emerge as the search engine of the decade is beyond me. But if anyone has anything to say about it, it's Marissa Mayer and her company Yahoo.