Yahoo (YHOO) CEO Marissa Mayer certainly has a lot on her plate. Being the new CEO of a company that has had five in the past year is certainly a challenge, and she can hardly afford to sit still. But one item that Mayer might want to consider adding to her agenda could spell the difference between success or failure during her tenure at Yahoo: she needs to either tell or ask the Board of Directors what Yahoo wants to be when it grows up.
Everything will flow from the answer to that question.
- Is Yahoo a tech company or a media company?
- Should it focus on growth?
- Should it focus on wringing maximum value out of its current platform?
- Are transformative acquisitions the answer (the killing of Flickr notwithstanding)?
- Is it time to sell?
Absent a firm understanding of what the goal is, Yahoo management has little hope of reversing the company's slide into irrelevance.
The trouble with technology companies that fall on hard times, and the industry more broadly, is that there is a tendency to reach for the next dose of innovation or deal making to return to growth. But trees don't grow to the sky and growth stories do not continue forever. Oracle (ORCL) CEO Larry Ellison was vilified when he began pursuit of competitor PeopleSoft nearly 10 years ago. Ellison maintained that consolidation was necessary in the industry, and he was right. Though Yahoo is in a different business than Oracle, the very same tech mindset that recoiled at Ellison's suggestion that the era of limitless (but not really) growth was over seems to be at work in the Yahoo boardroom.
How else to explain the short, successful yet unappreciated tenure of Carol Bartz? Carol Bartz was brought in as CEO following the attempt by co-founder Jerry Yang to right the ship. In 30 months, Bartz did exactly what some (myself included) thought necessary at Yahoo: she maximized profitability and squeezed all the milk she could out of a dying cow. Net income increased by more than 50 percent during her time at the helm. And yet, she was hated. Carol Bartz showed Yahoo's board what it was to be a company focused on blocking and tackling, and as the picture came into stark relief, the board recoiled, leaving the fundamental question of what was next unaddressed.
The problem is that the board seems to know what it wants to hear, and it is just shopping for a CEO to parrot the right lines. Yahoo (the company's name stood for: Yet Another Hierarchical Officious Oracle), one of the darlings of the 90's dot-com boom, does not want to believe that its best days are behind it. The Board does not want to believe that turning down a $44.6 billion offer from Microsoft (MSFT) in 2008 was a horrific decision. But they are, and it was.
A review of Yahoo's most recent annual report is illustrative:
Sales: From 2007 to 2011, sales declined nearly 29%, dropping below $5 billion in 2011 from nearly $7 billion in 2007. Digging below the surface gives additional cause for concern. Display revenue was essentially flat between 2010 and 2011 (due to the denominator effect it rose to 43% of sales, from 34% the prior year). Search revenue fell $1.3 billion, and dropped to 37% of sales, from 50% the prior year. Other revenue (comprising listing, transaction and fee revenue) declined $37 million, and rose to 20% of sales, from 16% the prior year.
The biggest takeaway from the annual report is that Yahoo is no longer mainly a search company. From 2009 to 2011 Search revenue has fallen from 53% of sales to 37%. Meanwhile, Display revenue has risen from 29% of sales to 43%. To illustrate the point even more vividly: in 2009 Search revenue (53% of sales) was larger than Display and Other combined (47%), by 2011 Display and Other combined (63%) were 70% larger than Search.
Profitability: Operating margin has risen appreciably, reaching 16.1% in 2011 from 10.0% in 2007.
Cash Flow: Operating cash flow over the past three years has been in a relatively tight band of $1.2 - $1.3 billion. The main driver appears to be the volatility in Earnings in equity interests, and should highlight to management a need to streamline those holdings.
Sale of Alibaba: The company's Q3 earnings release highlighted the potential of Yahoo to deliver substantial shareholder returns. With after-tax proceeds of $7.6 billion, this sale represents a wonderful accomplishment by management and presents the opportunity to deliver substantial returns to shareholders in the form of a one-time dividend. Yahoo now has Cash, Cash Equivalents, Marketable Securities and Investments totaling $9.4 billion.
Thesis: Yahoo is too heavily discounted by the market, and investors should pounce on this opportunity. Yes, it has suffered from strategic drift for too long, but the fundamentals are compelling and it appears that in Marissa Mayer, the Board of Directors has finally found a CEO it will listen to. Currently priced at 9.0x TTM EBITDA and a Price/Book of 1.3, Yahoo is a steal, especially when compared to the valuation of Mayer's prior company, Google (GOOG).
The beauty of Yahoo as an investment is that it is discounted so heavily that management does not have to get everything right to generate compelling returns. A focus on returning money to shareholders, opportunistically acquiring companies in adjacent niches (regardless of what Mayer says, I see Zynga (ZNGA) and Netflix (NFLX) as intermediate-term targets) and pushing a more compelling story to advertising partners should generate rich returns.
- Market Cap of $237 billion
- TTM EBITDA of $28.8 billion
- Thesis: Might still be interested in revisiting the 2008 offer, obviously at a much lower value.
- Facebook (FB):
- Market Cap of $53 billion
- TTM EBITDA of $1.1 billion
- Thesis: Buy deeper relevance with advertisers, broader array of offerings. If Yahoo buys Zynga it might go from an interesting idea to a strategic imperative.
- Market Cap of $1.7 billion
- TTM EBITDA of -$475 million
- Thesis: Buy into social gaming cheap, leverage expertise to become acquisition bait for Facebook.
- Market Cap of $3.9 billion
- TTM EBITDA of $147 million
- Thesis: Buy a fee-based revenue stream and relevance in consumer entertainment.