Yahoo Is Gambling On The Right Mix Of Acquisitions

| About: Yahoo! Inc. (YHOO)

Yahoo (NASDAQ:YHOO) is taking the bull by the horns in its bid to mount competitive pressure on rival Google (NASDAQ:GOOG). The Sunnyvale, CA-based internet search laggard recently acquired social blogging site Tumblr for $1.1 billion, which many people thought to be an overvaluation of David Karp's company. Unconfirmed reports now indicate that Yahoo has also placed a bid for online video streaming company Hulu, where it is likely to face stiff competition from a selection of private equity firms. KKR & Co. (NYSE:KKR) and Silver Lake Management are also said to have placed their offers in what promises to be an interesting bidding war.

In January 2013, Yahoo CEO, Marissa Mayer did point out that the company's priority was user engagement. At that time, many would have wondered what she meant, but it's all becoming clear now. Yahoo's recent acquisition of Tumblr is a clear indication of the company's intent on increasing user engagement. The company's rumored bid on Hulu is also an attempt to boost user engagement via video streaming, which competes directly with Daily Motion and Google's YouTube.

The Power of Social Networking in User Engagement

The popularity of social networking amongst the youth is becoming a key aspect in web-user engagement. This is well proven by the fact that Facebook (NASDAQ:FB) leads all social networks in term of user engagement. Most people are spending more time on social media than general, e-commerce sites. The only challenge here has been monetization of traffic, as the users prefer interacting with their friends and connections, rather than browsing through a display of ads. A recent study showed that we spend more than 230,060 years ever year on social networking sites, which emphasizes the level of engagement with social networks.

Even professional networking giant LinkedIn (NYSE:LNKD) has realized that user engagement is as critical, as it seeks to boost its search business. The company acquired Pulse for $90 million, 90% to be paid in stock and the remaining 10% in cash. Pulse was founded in 2010, with the goal of helping organize news feeds in mobile platforms, and has about 30 million users spread across both iOS and Android. Dave Morin, a Facebook developer once noted that in future, the focus would not be on building a huge network of users, but rather increasing user engagement. It seems as though we are getting to that stage.

Yahoo's acquisition of Tumblr, and a Bid on Hulu is a Gamble, but a Good Mix

Yahoo's buys are without a doubt a gamble. The company is taking a huge risk in terms of money used to purchase Tumblr. Now with Hulu rumored to be another probable acquisition, one would wonder just how much money Yahoo could afford to burn. However, it is burning cash for the right reasons. Indeed, why keep the cash, if there are certain opportunities that could reignite the company's competitive edge in search? Marissa Mayer did indicate that the acquisition of Tumblr would include featuring the social blogging network's content on its news feed. Yahoo could use this to optimize its other content, and hence boost traffic.

Additionally, Yahoo is bringing on board a network composed of youthful users. This promises to boost user engagement and the company's chances of monetizing traffic. The acquisition of Hulu, as noted would build Yahoo's competitive edge in streaming media. Google is well set with YouTube, after Yahoo's attempt to take a majority $200 million stake in Daily Motion was shot to the ground by the French government last month. This further affirms why Yahoo is desperately moving for Hulu, and will do everything possible to get the deal.

Recent Results Indicate Improvement Under Marissa Mayer

Yahoo has been rebuilding its face since Marissa Mayer took over last year. The company has done this very successfully beginning with staff and then to its web interface. According to the company's most recent quarter results, engagement across the Yahoo network is up 25%. The company also launched news mail services for iOS and Android, which have lifted the number of daily users of the company's apps by 50% from the previous quarter. Additionally, the company has seen a significant rise in the number of photos being uploaded on Flickr, which grew by 50%. Flickr is one of Yahoo's acquisitions, which analysts once feared was declining in usage.

The company also beat analyst estimates on earnings despite recording reduced revenues for the quarter year-over-year. Traffic Acquisition Costs remain a part of Yahoo's bottlenecks to increased revenues.

The company's acquisition of Tumblr will take a significant time before B.E.P. According to Forbes, Tumblr reported $13 million worth of revenues in 2012. However, this is mainly due to the fact that Tumblr revenue barely comes from ads. The platform is not best known for usage by advertisers, something Yahoo will have to change if it is to boost revenue generation from its newly acquired unit. This would also result in another challenge of chasing away members of the social blogging network. However, if Yahoo manages to successfully place ads on Tumblr, this could boost the new acquisition's revenue ten-fold and upwards. A more realistic figure of about $100 million or more, in the first few years would be achieved if Yahoo can get an average of $1 per user from Tumblr's 108 million blogs. This should not be difficult for the search company.

The rumored Hulu acquisition would also bring on board in excess of $700 million per year going by the company's 2012 results. This would come along with other synergies as well as diversifying Yahoo's portfolio of revenue streams.

Investment wise, Yahoo is already doing a great deal for investors by fulfilling the $3 billion money back program, which should keep their worries about the idle cash in the back seat. Meanwhile, Yahoo can make cutting edge investments with the cash as long as they mix well with he company's strategy.

The Bottom Line

If Yahoo chose to sit on the $4.4 billion in cash, then there would be minimum risk attached to it depending on the form the cash is kept in. However, investing the cash in such an important part of the business strategy promises incremental returns, on positive results. It is a gamble, but every return comes with a certain amount of risk, and Yahoo's acquisitions are definitely the right mix for its strategy in user engagement and traffic monetization. This has been a critical area in the company's battle with Google, where its performance has been underwhelming. With the likes of twitter, LinkedIn and Facebook also beginning to challenge the status quo, Yahoo is definitely making the right moves, at a critical time.

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.