Yahoo Beats Estimates - We're Changing Our Tune

| About: Altaba, Inc. (AABA)

Web content firm Yahoo (YHOO) reported better than expected third quarter results Monday afternoon. Revenue grew 2% year-over-year to $1.09 billion, a touch better than consensus estimates. Operating income per share, which excludes the gain on the sale of Alibaba, grew 66% year-over-year to $0.35, which was much better than the consensus expectation. We had originally been skeptical of a turnaround as our previous article on the firm noted (click here), but CEO Marissa Mayer has really got things going.

Most of Yahoo's profitability gains came from shrinking the workforce, which fell by 1,700 employees on a year-over-year basis, to 12,000. Sales and marketing expenses were cut 7% year-over-year to $269 million, while product development costs fell 5%. This focus on cost cutting allowed the company to generate adjusted operating cash flow of $496 million, up 39% compared to the third quarter of 2011.

In addition to strong cost controls, we saw decent revenue performance in both display and search, which were flat and up 11%, respectively. Though the company seems reasonably excited about its partnership with Microsoft's (NASDAQ:MSFT) Bing, the agreement has yet to be renewed and expires in April 2013. Yet, less than $100 million of revenue is at risk, so we don't view the agreement as terribly important one way or the other. While Bing's search results may or may not be better than Google's (NASDAQ:GOOG), we don't see any firm stealing significant market share in the near-term. Mayer remarked that the company was disappointed in monetization, but we think renewing the deal may free Yahoo to work on other areas of the company rather than allocating intellectual resources towards search.

More importantly, Mayer elaborated on her vision for Yahoo. She believes approximately half of the company's workforce should be dedicated to enhancing and developing mobile products. We suspect Yahoo, which is significantly smaller than competitors like Microsoft and Google, might be more nimble in negotiating the transition to mobile. Mayer also noted that the company, which established a $750 million credit line, plans to focus on acquisitions under $100 million to add to the firm's product suite. The firm will return some of the Alibaba cash to shareholders via share repurchases, which will help reduce future dilution from talent acquisitions.

Overall, we liked Mayer's honesty and admission that Yahoo will have to be "predominantly a mobile company." Even after accounting for taxes to be paid on the Alibaba sale and share buybacks, Yahoo is well positioned with over $4 billion of cash to invest in the business via acquisitions and organic growth. We think it's too early to evaluate the firm's strategy-Mayer's been on the job for less than 100 days-but we certainly admire her leadership and respect her experience with Google. Still, shares score only a 3 on the Valuentum Buying Index (our stock-selection methodology) so we aren't interested in adding the name to our Best Ideas Newsletter at this 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.

Additional disclosure: GOOG is included in the portfolio of our Best Ideas Newsletter.

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