Yahoo's Valuation Is Finally Reasonable

Brian Bolan, research analyst at Jackson Securities, sent a note to clients upgrading Yahoo (YHOO) to Hold from Sell while lowering his estimates and price target:

Company Description

Yahoo! is an internet search and technology platform for all media that has established itself as the leader in its growing market. Yahoo! has transitioned to more than just a search engine to become a destination site and platform for new media delivery.

Valuation and Recommendation

Following speculation of a buyout from Microsoft (MSFT), we lowered our rating to Sell from hold. Within weeks, Yahoo! CEO Terry Semel announced his resignation and the appointment of Co-founder Jerry Yang as CEO. While we are still waiting to see what Yang has in store for Yahoo, we note that the valuation has become more reasonable and our SELL rating is no longer warranted.

We also note that a management transition and an innovation in the email platform have buoyed our expectations for the coming turn around announcement.

Updating or 2H07 earnings estimates for Yahoo!

Yahoo! reported revenues of $1.243B and earnings of $0.11 per share in the most recent quarter, we believe that 3Q07 will be a challenging one for the company and investors alike. We have lowered our earnings estimates for a number of reasons, the most important one is continued loss of share to Google in search. Our model suggests that Yahoo! will show a precipitous drop in operating income in the quarter and there may still be headline risk associated with this. That said, we believe that most of the negative sentiment is already baked into the stock at current levels. We believe that following the earnings announcement for 3Q07, which is scheduled for mid October, that the stock will begin to recover setting it up to be the story stock of 2008. With the stock sitting at a “low water level” we are upgrading our view on shares of Yahoo!.

Yang and 100 days…

On the conference call, Jerry Yang noted that he and the management team will spend about 100 days to map out a strate gy for success. While we were disappointed with this at the time, we believe that it allowed for a thorough analysis of what the companies needs are going forward. We note that the recent release of a new email feature which allows messages to be sent to mobile phones as positive sign and first step in fulfilling a promise made the most recent conference call.

During the 2Q07 conference call Mr. Yang delivered four key elements vital for temporary success for Yahoo!. The first key element is to focus on areas of greater growth and profitability. Second is an emphasis on technology to create platforms that can easily scale with use. Faster decision making and better execution was third.

Finally, a new and improved culture of winning for Yahoo! rounded out the temporary keys to success at Yahoo!. The addition of messages to mobile is clearly following in those footsteps, as it is a growing market and a technological innovation.

We believe that this upgrade to Yahoo! email will set the tone for future upgrades for other services at Yahoo!.

We expect the Jerry Yang makeover of Yahoo! to contain several aspects of improved content on the site. Evidence of this is the recent purchase and immediate implementation of Rivals.com to the Yahoo! Sports section as well as destination for all things celebrity, OMG.

The addition of Rivals.com suggests that unique niches are targets for potential acquisitions. In paying approximately $100M for the content driven add-on, Yahoo is signaling that being a destination site is high on its list of goals. Keep in mind that a third party ratings agency has recently shifted its focus from hit and or page views to the amount of time spent on a site.

In building the OMG site, Yahoo is not baking down from the celebrity sites that have already become the defacto standard in the space, namely PerezHilton.com and TMZ.com. So while content may or may not be king, we see Yahoo! expanding content in hot areas of the web through building and buying.

RPS increases and checks suggest that Panama is improving

It seems that the long awaited Panama ad system is finally starting to stem the losses the company has been seeing in the search business. Revenue Per Search [RPS] increased significantly in the prior quarter and we are expecting somewhat similar gains in 3Q07 and 4Q07 despite continued loss in overall share.

SmartAds

SmartAds are advertisements that rely on the depth of knowledge that Yahoo has on its users. A tool that only recently has been released, SmartAds are a source of high expectations from management. Currently, SmartAds are only found in the travel section of Yahoo!. SmartAds will integrate the company's demographic, geographic and behavioral targeting capabilities with an ad construction platform that customizes ads in real time.

Valuation

In our last research report on Yahoo!, we summarized the movement of the stock and our rationale behind our Sell rating. We also maintained our target price even as we noted that we believe that the stock would trade lower in the coming months.

We are upgrading our view on shares of Yahoo!, based on a several reasons. First, we believe that as estimates have come down the stock has followed and this could mark the low water level. Secondly, we believe that Panama will continue to outperform estimates and rollouts across the globe will provide a tailwind. The follow through on the expansion of technology based platforms is evident, and we expect to see similar announcements in the future from the company.

That all being said, we are lowering our target price on shares of Yahoo! to $22 based on our lower expectations for earnings in 2007. The price target represents a multiple of 54x this years earnings. Following the mid October release of 3Q07 earnings, we will publish our 2008 estimates for Yahoo!

Disclosure: Neither Jackson Securities nor any of its publishing analysts or their immediate family members has a position in the securities described herein.