Why Yahoo! Can't Go it Alone

Could Yahoo! survive as a stand alone company, much less a web portal?

Getting the answer to this question now on the lips of  Wall Street traders, and likely billionaire Carl Icahn who has sunk tens of millions of dollars into Yahoo!, shows how weak Yahoo!'s business is as it appears to be striving to go it alone and instead tries to strike an ad partnership with Google.

Microsoft now wants to buy only what it wants, Yahoo!'s search engine, while investing a minority stake in the rest. The idea apparently has met with a lukewarm response from Yahoo!, and is seen as pressure by Microsoft to put public pressure on Yahoo! not to pursue a separate search-ad deal with Google.  

A deal for just Yahoo!'s search engine would clearly cost Microsoft much less, estimates have it at $21b, lower than a full $40b+ buyout Microsoft initially offered. Collins Stewart analyst Sandeep Aggarwal estimates Yahoo's display advertising operations would be worth $14b and its international holdings at $9.25b.

But whether Yahoo! could survive as a stand alone company, or even as just a portal is a big question, the question of the hour.

It depends if Yahoo! chief executive Jerry Yang and his cohort can succeed in their ambitious turnaround plan, a plan that would turn Yahoo! into a premier portal for Web surfers, the starting point for consumers logging on, and whether that would be enough to attract the advertising dollars that would supposedly follow them.

Yang staunchly believes the Sunnyvale-based company is on the brink of a turnaround that will prove he was right to turn down Microsoft, a turnaround he thinks will prove Yahoo! is really worth more than $50b. Starting next year, Yang has (over)promised that Yahoo!'s net revenue will increase by 25% annually--more than doubling its recent rate of growth.  

Here is the case both for and against Yahoo! as a stand alone company. 

I said from the beginning, the day Micosoft's offer to buy Yahoo! was announced, that the Microsoft-Yahoo! battle would be a fight over the deal's value, that Microsoft would be seen to be overpaying for Yahoo! Internet trends, notably in ad spend, are just one part of the serious challenges Yang must contend with.

First, the overly optimistic--with emphasis on overly--view of long-term growth in Internet advertising.

Seemingly unbeknownst to the cheerleaders on Wall Street, Yahoo! has been in a bit of a profit slump, its operating expenses have been soaring, much of its profits come in the form of paper gains from its stake in a Chinese company, so the big question is, does Yahoo! have the wherewithal, the stamina, and the earnings power to turn its throng of users into a profitable portal?

The key here is how much a Yahoo! portal would get in the way of online advertising. The three companies, Yahoo!, Google and Microsoft are fighting over online advertising, thought to be worth about $40b a year, a figure that is expected to double by 2010.

However, there's a serious debate about those numbers as they rosily factor in estimates about the amount of ad dollars spent on places like social networking sites and sites such as YouTube, when a growing number of analysts note that advertising doesn't seem to work on such sites.

Who wants to waste time looking at distracting ads when you are talking to your friends or watching videos starring talking dogs? Aren't ad dollars more effective when people do laser beam searches for furniture or pet medicine on line?

Also, Yahoo! has a confusing site that turns off users and its display ad results are not that strong. Yahoo! tosses its vast offerings at web surfers willy nilly, and makes users, including me, feel as if they are chasing gnats in a hurricane. I often wonder whether I am getting attention deficit disorder just by looking at its unfocused site, as I reach for the Ritalin. Instead, Google's site has more focus and it seems to prioritize its offerings.

What Yahoo! has going for it is what it claims is its daunting amount of traffic, nearly 500m unique users per month from around the planet. Also web surfers spend a lot of time on its site each month, since Yahoo! has one of the most popular e-mail services around, as well as news, financial information, sports and music offerings. Yahoo! visitors averaged just over three hours and 12 minutes on its site in March, according to Nielsen Online. It came in second to AOL, which averaged nearly four hours.

Google averaged less, about one hour and 16 minutes of time spent on-site by its average visitor, but the numbers show it is gaining fast. Of course, Google is tremendously efficient in extracting revenue from its visitors because of its dominant position in search, where it garnered a 68% market share in April versus a 20% for second-ranked Yahoo, according to Hitwise.

But another problem is Yahoo!'s display advertising business. That business has not been that strong. Plus this business may get worse. Recent data on advertising spend patterns show that online advertising buyers are moving toward search advertising and away from display ads. The New York Times says "the prices paid for online ads bought through display ad networks dropped 23% from March to April, according to PubMatic." That's huge.

Also Yahoo! has been in a bit of a profit slump. Without huge paper gains from its stake in Alibaba, a Chinese Internet company, its net income and operating income would have been microscopic, down more than 70% and 90% respectively. See my prior blogs, "Why Microsoft Should NOT Up its Bid for Yahoo!" and "Why Carl Icahn May Fail at Yahoo!"

Also don't buy into just yet the naively bruited about talk of a partnership between Yahoo! and Google, where Yahoo! would outsource at least some of its search advertising to Google and thus get $1b in extra annual cash flow.This deal would let Google show some of its ads alongside Yahoo!'s search results.

But glowing talk of such a deal ignores the fact that it could easily be stopped, as it would put both in the crosshairs of the anti-trust police. Such talk underestimates the power of the anti-trust cops in Washington, DC as well as opposition from Microsoft's top executives, including chief exec Steve Ballmer, who is not shy about attacking mergers between competitors as monopolistic to the anti-trust squads in Washington and overseas. Any partnership between Google and Yahoo! would surely face antitrust obstacles as the two companies would command more than 80% of the U.S. search advertising market.

With Yahoo!'s share price still trading with a merger premium built in, as if a merger or some kind of a deal is inevitable, the real question now is whether shares in Yahoo! will fly south faster than a goose in winter if Yang stubbornly opts to chart an independent course for the company he co-founded.

Footnote: Check out this article from the Mercury News, excerpts reprinted below.

Yahoo! is allegedly seeking to conceal large portions of a shareholder lawsuit alleging the Internet company's board improperly thwarted Microsoft's $47.5 billion takeover offer, raising shareholder questions over the motives for the secrecy, the Silicon Valley newspaper reports.

The report says in a letter sent Friday to the judge overseeing the case in Delaware, a lawyer for the shareholders argued Yahoo! is trying 'to whitewash embarrassing documents' because the company thinks the information will damage the board's efforts to repel a challenge by activist investor Carl Icahn.  

Angered by the board's handling of Microsoft bid, Icahn has nominated an alternate slate of candidates to oppose Yahoo!'s 10 current directors - including chief executive Jerry Yang - at the Sunnyvale company's July 3 annual meeting.

Yahoo! is trying "to sanitize the public record and maintain a cloak of secrecy regarding unflattering evidence of breach of fiduciary duty," shareholder attorney Joel Friedlander wrote in a letter to Chancellor William B. Chandler III. The redacted documents include information about an employee severance plan that Yahoo adopted shortly after Microsoft made its initial bid Jan. 31 and notes about a conversation between Yang and Microsoft CEO Steve Ballmer, Friedlander wrote.Yahoo had no immediate comment Friday. Generally, companies often seek to keep parts of publicly available lawsuits under seal for competitive reasons.

A hearing on the request to unseal the disputed material has been scheduled at 10 a.m. today in Chandler's court, said Mark Lebovitch, another lawyer representing the shareholders. He declined further comment.

The concealed information was gathered during the discovery phase of the nearly 3-month-old suit. If they're made public, the documents could become fodder in Icahn's campaign to remove Yahoo!'s board.

The information would be particularly damaging to the board if it suggests the directors deliberately took steps to make Yahoo! more expensive for Microsoft.

The report says Friedlander's letter indicated the redacted documents include estimates about how much Yahoo!'s employee severance plans would cost Microsoft in a takeover - information that could be of particular interest to shareholders trying to figure out if the current board acted in their best interests.

Yahoo! had previously disclosed the plans would give its 13,800 employees anywhere from four months to two years of pay. Every $1.4 billion in severance cost theoretically would translate into about $1 per share less that Microsoft would have available to offer Yahoo shareholders.

The report notes that Ballmer orally offered $33 per share, or $47.5 billion, but then withdrew the bid when Yang held out for $37 per share. Legg Mason money manager Bill Miller, whose fund is Yahoo!'s second largest shareholder, has publicly said he would have happily supported a Microsoft offer of $34 per share.

Friedlander's letter also indicated the redacted documents include comments that Yahoo!'s top executives made about the severance plans."