Yahoo! Earnings: Company Continues To Face Challenges

Brian Bolan, research analyst at Jackson Securities, reports to clients on Yahoo's (YHOO) recent quarter and maintains his HOLD rating for the company. His note follows:

First, the Good News
We were pleased to hear that the rollout for Project Panama is on schedule and the first phase is in motion. While this is good “headline” news, we do not expect to see a financial impact until 2Q07 results are released. Going forward, we do not believe there will be headline risk related to the Project Panama issue that concerned many investors in the prior quarter.

Project Panama, the code name for the improvement in search monetization, had been delayed from the third quarter into the latter half of the fourth quarter. We now expect a launch of Project Panama in the end of the 4th quarter with full advertising participation in the first half of 1Q07.

Project Panama is expected to improve the relevancy of searches and drive better monetization rates. While Yahoo! management has noted in the past that their searches are mostly the same as that of Google (GOOG), we note that Google has had superior financial performance of late.

The rest of the news
The rest of the story on the conference call mostly pointed out challenges the company will face over the next 12 months. We believe one of the key challenges will be the question of inventory.

This quote from the conference call tells us that an inevitable shift is beginning to occur :

“The market is going through a significant transition with new forms of inventory becoming available from a range of new and established competitors.” - Yahoo! CEO Terry Semel

This tells us what many had believed for some time, and that is that graphical advertising is taking over and new forms of advertising, such as those advertisements one would see on a web video production are right in step with the higher end graphical ads. The vast majority of what Semel was referring to is the inventory and page view growth of the social networking sites.

Earnings
Earnings met our expectations of $0.11 per share, but revenue was just slightly below our estimate of $1.137B. During the quarter we lowered our estimates as the CFO noted that the company would come in at the bottom half of the guided range.

With the expense of stock options, investors are getting a better picture of how companies are rewarding their employees. Yahoo! continues to use stock options to reward employees, and it appears its offering up more and more stock options in order to retain its human capital. In the previous quarter, the company spent $100M on stock based employee compensation in the quarter, or roughly $9,500 per employee. This quarter saw an increase to $121M or $11,000 per employee.

Click Fraud
Click fraud almost vanished from the discussion, but this is not to say that it isn’t still out there. An industry wide problem, click fraud has been measured at about 14% of all ads that were clicked on. We believe the number may be a little lower and that it is a very difficult idea to get your arms around fully. We still believe that click fraud will continue to plague the industry as a whole and it will only be a matter of time before the press plays that tune again. Being an industry wide problem, we believe the risk to be mostly headline in nature, and not specific to Yahoo!

Valuation
We are maintaining our hold rating on the shares of Yahoo!, and in the coming weeks we will roll out our estimates for 2007. At that time we expect to see some change from our current target price of $33.

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