Did Yahoo Underpay For Tumblr?

May.23.13 | About: Yahoo! Inc. (YHOO)

A media storm ensued following Yahoo's (NASDAQ:YHOO) $1.1bn purchase of blogging site Tumbr. As a part of this coverage, analysts and Yahoo management debated the logic (or lack thereof) behind the purchase, and how it would affect Yahoo's strategy going forward. Two of these interviews stood out for the sharp distinction they drew between the two sides of this debate. First, when asked if Yahoo overpaid for Tumblr, RBC (NYSE:RY) analyst Mark Mahaney said this, "you cannot justify this on a DCF, ROI basis" (40 seconds in). Second, when asked the exact same question, CEO Marissa Mayer responded, (1:10 in) "we actually did a lot of different analyses looking at things like DCF, discount to EBITDA, precedent transactions, and a lot of different methodologies and all those methodologies supported this valuation". A lot of people have weighed in on this matter, and landed on opposite sides of the debate. In this article, I, too, will join the fray and offer my own analysis. Specifically, I will draw a comparison between social media sites -- like Tumblr -- and compare them to the network TV stations -- CBS, NBC, FOX, ABC. I will argue that both of these types of media properties offer users/viewers/customers free content in exchange for their eyeballs. I think by examining the valuations for the network TV stations, and using that as a basis of comparison for social media sites in general, and Tumblr specifically, we can begin to understand the logic behind Yahoo's transaction.

Network TV Stations

Network

Viewers (in millions)

Revenue (in millions)

Revenue Per User

CBS (NYSE:CBS)

11.86

$6,500

$548.20

NBC (NASDAQ:CMCSA)

6.96

$4,000

$574.71

FOX (NASDAQ:NWS)

7.06

$4,000

$566.65

ABC (NYSE:DIS)

7.85

$3,914

$498.85

Click to enlarge

A word about network revenues. Only Disney breaks out exact revenues for their network advertising, the rest I have estimated based on the following:

  1. CBS -- CBS reports network TV advertising as part of their Entertainment Segment. CBS reported revenues of $7.6bn for the entire segment. However, this segment also includes the company owned affiliate stations, and radio properties. Considering CBS includes both of these media properties in this segment, I estimated their worth at around $1bn.
  2. NBC -- Comcast reports NBC in their broadcast TV segment, and reports the ad revenues from this segment at $5.8bn. However, this segment includes Spanish Language station Telemundo, forcing us to estimate NBC's overall share of the revenue, which I estimated at $4bn.
  3. FOX -- News Corp, like CBS, includes their company owned stations within their Network TV segment, which notched $4.78bn in revenue. However, they don't have any radio properties, like CBS, as such I deducted $780mm of revenue from those stations.

I am not intending to provide a scientific statement for the network TV revenues, which would entail much labor, and little in the way of output, but I feel that these numbers fall within the likely range of recognized revenues based on the above.

The types of advertising offered by these stations differs from the advertising offered by Google (NASDAQ:GOOG) Search. Google Search offers primarily lead generation -- when a user submits a query they have voiced their desire for information about a certain product, and as such Google can target that user accordingly. The network TV stations, on the other hand, offer far more in the way of brand building/recognition. Ads, on say, the super bowl, don't tell you the cost benefits of the product advertised, rather they want to engender a feeling or emotion within their audience. While this doesn't hold true across the board (network TV also has more 'lead generation' type advertising) it does for the most part.

Social media, too, offers advertisers a way to target users who have not expressed any desire for a product. Social media companies, and network TV stations, don't have a request for certain ads from you, but they know based on the audience a show draws, or based on who you follow what you might find interesting. The content generated -- professional in the case of network TV, and user generated in the case of social media -- draw users/viewers and allow the executive to sell advertising against the content generated.

In the next section I will analyze the different social media sites, and value the sites based on their user base.

Social Media Companies

The following table shows the major social media companies and their daily active users (DAU's)

Network

DAU's (mm's)

FB (NASDAQ:FB)

665

Tumblr

6.8

Twitter

7

Google+

20**

Instagram

7

Click to enlarge

**monthly

A couple of notes -- first, I based all of these numbers (except for FB) on estimates. Second, I think we need to use daily active users as the most apples-to-apples comparison between Social Networks and Network TV Stations.

Now, using the revenue per viewer figures for Network TV Stations in the case of Social Networking sites would give a site like Tumblr revenue projections of $3.5bn! Clearly, we cannot do this. Why? Because the level of engagement users have with these sites falls way short of their level of engagement with Network TV shows.

However, even bringing down the revenue per user to more realistic levels, we can see the tremendous opportunities available to a site like Tumblr. In its most recent quarter, FB reported revenue per daily active user of $2 for the quarter, or $8 annualized. Using that figure to model Tumblr would give it around $50mm in revenues, not so great. But I think in trying to understand Yahoo's thinking we need to take three important items into consideration.

  1. Tumblr has shown tremendous growth, and while it has not, and will never reach the level of FB -- further growth will drive revenues
  2. Ad dollars continue to migrate from offline to online. True, currently FB only earns $2/user, but as ad dollars continue to migrate we should see that number rise
  3. Tumblr's user generated content has more in common with Youtube than FB. While all three qualify as social media -- considering they produce user generated content -- FB functions more as a social directory, as opposed to a place for people to post long form thoughts or videos. Tumblr generates higher quality content, and as such can command higher ad prices.

Most importantly, we need to realize that now that Tumblr can harness Yahoo's ad sales platform that can really start to turbocharge their revenues. Despite its reputation amongst most people I know, Yahoo still remains a major player in the display ad market. Last year they clocked in $2.1bn in display ad revenues -- making them one of the major players in the market. Yahoo's established relationships and infrastructure in this field will surely help Tumblr begin to bring its monetization plan to life.

Putting It All Together

Taking all of this data -- audience and revenue numbers for both network TV stations and social media -- we can attach the following valuation to Tumblr.

Click to enlarge

I drew info on past user growth from sources quoted above, and I modeled out similar user growth going forward the next three years. Revenue per user is based on current statistics for internet ad spend per user, and multiplied that by active users. Considering this analysis we need to ask did Yahoo underpay for Tumblr. A 28.83% return on a media asset should force us to ask this question.

Critically, I want to retain the comparison between network TV's and social media -- both have content that generates eyeballs, but not revenue from the users directly. Network TV and Social Media companies can then sell advertising against this content.

Conclusions

A number of secular changes will help Yahoo along the way in monetizing the Tumblr acquisition. First, world population today stands at 7bn, but shockingly only 2.4bn, or 34% of people actually have an internet connection. These low numbers owe a lot to the lack of access in Asia and Africa, where internet penetration stands at 15.6% and 27.5% respectively. Even in the USA 22%, or close to 68mm people still don't have internet access! This trend will clearly shift, and as it does, and more people come online, internet properties, like Tumblr will continue to see increased growth. Second, this will lead to a worldwide shift in ad dollars. Last year marked the first time ad dollars reached $100bn, but it only accounted for 20% of the ad spend. Advertisers still spend the majority of their money on TV programming, radio, and print -- "traditional advertising". This obviously contributes to the low revenue per user that we saw when comparing FB with traditional network TV stations. As the online ad market matures, and ad dollars follow, we should see increased revenue per user, and thus increased revenues for online media properties, like Tumblr. Putting this all together -- more people coming online, and more money spent online by advertisers -- should easily translate into more revenue for sites like Tumblr. Whether or not they will execute and take advantage of these trends remains unknown, but Yahoo has put themselves in the position to play in the game, and take a stab at success.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.