Can Yahoo Be Your Ideal Pick In The Online Ads Industry?

| About: Yahoo! Inc. (YHOO)


The recent acquisitions made by Yahoo have had a positive impact on its user base. However, the competition from Facebook and Google is fierce and needs to be tackled well.

The renewed focus of the company on making product improvements is praiseworthy. Also, the gain in display ads revenue puts Yahoo in favorable position to leverage the massive scope.

As per the PEG ratio, Yahoo is over-valued as compared to its peers and therefore, bears a higher risk of a downside in coming quarters.

Since Ex-Googler Marissa Mayer took over the reins of a struggling Yahoo (NASDAQ:YHOO), it has turned into a new products Frankenstein that has been constantly innovating on expanding its product portfolio both by organic and inorganic means. Over the last couple of years, Yahoo has made approximately 37 acquisitions that include the likes of Tumblr, Summly and Also, this sharp focus on improving products and expanding to include new ones has been received well by the Street as the stock price has more than doubled from the time Marissa Mayer became the CEO.

Wooing users and tackling competition

Having worked for a while in digital advertising industry, I have come to realize the extreme significance of user data for advertisers. Thus, for online ad companies like Yahoo, it is of mounting importance to increase the count of existing and unique users to its own and associated websites. Of late, Yahoo has grasped the need to increase user engagement via interesting content so as to attract a higher number of users with the ultimate motive of gaining advertising money.

In one of my last articles, I highlighted the current pecking order in the online advertising as per which Google (GOOG, GOOGL) is the market leader with a lion's share of around 32% of the total advertising revenue. While Google occupies the leadership position, Facebook (NASDAQ:FB) is the runner-up that every other player in the industry should be worried about solely because of the data capability that this social media giant possesses. Besides boasting over 1.28 billion monthly active users of which around 63% visit the Facebook website daily, the company has also garnered a huge user count on Instagram (200 million monthly actives to be precise).

Therefore, it is not hard to imagine the revenue generating potential that Facebook possesses and why it could become an advertiser's favorite in a few years. While I cannot say that Yahoo has also achieved ground-breaking numbers in terms of user base but definitely the company has shown abundant progress since its struggling years. As this article from Trefis highlights, Yahoo reported a jump of around 18% in the number of monthly unique visitors in 2013 as compared to 2012. Yahoo has been working tirelessly on amalgamating technologies from all its acquisitions which would definitely bode well for the company from an ads business viewpoint.

Product improvements galore

Interestingly, the company has not limited its product-related strategies to acquisitions and expansion but stretched it to revamp and rejuvenate its existing products. For instance, the company recently launched its overhauled Yahoo mail app for iPad after having rolled it out for iPhones, iPod and Android devices earlier this year. It is a multi-faceted app that allows an user to access many of Yahoo's services plus its newly launched digital magazines like Yahoo Food, Yahoo Beauties etc. My belief is that if the company maintains this innovation streak and sharp focus on products, then it will definitely rank up in content generation and user experience in the future.

Display ads have immense scope

In the first quarter of 2014, the display ads segment of Yahoo sprang a surprise for investors and analysts as it reported a revenue of $409 million (2% y-o-y growth) after falling for a couple of consecutive quarters in 2013. The tremendous potential of display can be clearly understood by this article based on a Nielsen survey, according to which, display ads only account for 4.5% of the overall spend in ads. While Google owns YouTube, the largest video content site, Facebook has also moved into the business of video ads to leverage the massive scope. As such, the jump in Yahoo's display ads revenue gives the desired launch-pad to the company to enhance its presence in display world.

A word on Valuation

A few quarters back, it would not have been worthwhile to comment on Yahoo's valuation as the giant was even struggling to keep up with the expectations. However, the recent deals and Yahoo's renewed focus on users has pushed up its stock by approximately 140% in last two years and calls for some introspection on its valuation.

Yahoo is currently trading at a forward P/E of 19.86 as compared to an industry average of around 41 while its P/S ratio is also favourable at 7.73 against industry's 10.54. While, both these ratios are in good shape, a look at PEG ratio sounds an alarm. Yahoo's PEG ratio at 3.80 is twice the industry average of 1.97 which implies that the company will have to generate faster growth in order to support the current price levels.

To answer the growth capacity of Yahoo in coming months, we can find some clues in the outlook given by the management. In the earnings call, Yahoo's management guided for Q2 revenue in the range of $1.12B-$1.16B i.e. higher than the consensus estimate of $1.08 billion. But, the operating income is anticipated to fall to $130M-$170M, indicating a negative growth from the previous year. Though numbers only cannot be a strict parameter for analyzing a stock, investors should definitely include them while making a decision.

Final words

There is hardly any doubt that Yahoo has traveled a long way since the induction of Marissa Mayer as the CEO and is now in a position to leverage from big opportunities in online advertising (search and display). Services like Tumblr, Flickr and Summly will pave the way for gaining unique visitors in coming quarters which could ultimately translate into more advertising revenue. However, I would still not recommend a position in this stock mainly because of the presence of better options in the industry. In contrast to Yahoo, Facebook represents a much robust and valuable investment at this point in time.

Disclosure: The author is long GOOG, GOOGL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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