Yahoo! Inc. (YHOO) Memo

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1 Name: Kana Yoshizawa College/School: CLAS Year: 2 nd Year Important Company Financial Data Price(4/24/2012): $15.43 Market Cap: $ 18.92B PE: Short ratio: 2.10 Diluted EPS: 0.88 EBITDA: $1.32B Total Cash: $2.21B Operating Margin: 16.02% Profit Margin: 22.28% Thesis / Key Points Failure of new business strategy that brings back focus on Yahoo s performance in United States. Yahoo s new CEO, Scott Thompson, who doesn t have enough experience in managing an internet company, announced that the company will cut around 50 Yahoo properties by He has recently lain off 2000 employees, which is roughly about 1/7 of all workers in the whole company. The majority of those who got fired were especially from the product development, local content, marketing, and research divisions with experience of working in Yahoo for decent years. The CEO states that there will be more layoffs on its way in the next few quarters, because Yahoo is doing so to restructure in Consumer, regions, and technology divisions as to focus on its core products like Mail, Finance, and Sports. However, he hasn t talked about the changes in detail yet, for example, how Yahoo will be formatting the changes and what products Yahoo is planning to improve on. Moreover, the management team is planning to sell or reduce its ownership in its Asian asset, which is the most valuable asset Yahoo currently holds, so that Yahoo would have enough cash to restructure its performance in US. Thus, it could be concluded that Yahoo doesn t have a clear vision of what it aims to do in the long run, and it is just doing thing to increase its margin by cutting costs, which also indicates its lack of confidence to generate enough revenue to sustain its growth in the short run. Incapability to sustain its growth in United States because of the failure to generate revenue from Display advertisement and Search outlooks. Yahoo s inability to generate revenue from its service In 2011; Yahoo s revenue by segment in America decreased by 33.98%. Yahoo is getting overwhelmed by its competitors in the internet Industry. As Exhibit 2 shows, according to the survey I conducted, 90% of the internet users prefer Google, and only 6.7% would choose Yahoo. Moreover, Yahoo s potential advertisement clients are also being taken away by its competitors. Because the big firms will go for Google for advertisement because Google has better brand recognition and better service. Thus, Yahoo should be targeting smaller shops and firms to expand its client base. However, as my VAR shows in Exhibit 3, small enterprises that are willing to advertise themselves on the Internet would be more inclined to go for Google, and Google has also been actively reaching out to them. Thus, Yahoo s potential ability to get more clients in the future will suffer unless drastic action is taken by the company. Display advertisement is one of Yahoo s most important sources of revenue. Indeed, in 2011, 43.34% of its revenue came from this division. Although the growth in this division may seem robust, the usage of Yahoo s key content categories will likely grow slower than the overall internet in 2011 as there is increased competition from social networks and vertically oriented content publishers pressuring the usage growth of yahoo s homepage, news, and games channels. The usage declines are likely to hurt revenue growth of both premium and non-premium display advertising, as the percentage of usage has dropped by 8% and the trend is likely to get worse in the future. On the premium side, the decreased time spent on yahoo s homepage could filter downstream to other yahoo channels, especially in news, games, and entertainment. On the non-premium side, increased social networking websites such as Facebook have been diversifying its service to , chat, and wall posts, which have all begun cannibalizing Yahoo! Mail usage, which generates 25% of Yahoo s non-premium revenue. The usage of Yahoo! Mail has been decreasing, as can be indicated from Exhibit 4.On the other hand, more than 50% of the users of Yahoo! Mail are aged between 35 to 45, yet the younger generation prefers Gmail. This indicates that the potential young users that Yahoo is in need of to generate more revenue from its Yahoo! Mail service will not come through for Yahoo! Mail and thus its service will not work in the long run. Moreover, Yahoo is unable to make a profit from its most popular features, such as Yahoo! Finance through display revenue as it only contributes 15% of Yahoo s non-premium revenue even though it is the most highly used program that Yahoo offers. Thus, even though display advertisement now seems to be growing, it will actually not be able to sustain its current performance due to the decreasing user base. The decline in usage would make Yahoo look even less appealing for future companies that are interested in presenting advisements on Yahoo. On the other hand, Yahoo s revenue from its search engine is likely to further deteriorate in the future, given that it has already decreased by 70.6% in Currently, 37.18% of Yahoo s revenue comes from Search revenue, and Yahoo has outsourced its search engine to Microsoft in October 2011 in order to better facilitate its search market in United States. However, this increased relevance would not have much of an impact on user behavior. Even though Yahoo search now has better algorithms, this would lead to a shift in search clicks from paid to free service, thereby creating the potential to hurt Yahoo s revenue in next few quarters. In addition, years of maintaining an inferior search product has tarnished Yahoo s brand in search, and publicity surrounding the outsourcing of its search engine to Microsoft will only reinforce the sentiment. Moreover, Yahoo s new algorithm is very similar to Google, yet if Yahoo wants to regain its market share from its main competitors, such as Google, it cannot just emulate what competitors have done. It needs to provide a product that is substantially better than the others in order to attract more attention. Also noteworthy is Yahoo s revenue from it search engine has been decreasing, as shown in Exhibit 5. Currently, it must now share 12% of revenue with Microsoft, which

2 could present a headwind to potential search growth. For example, Yahoo s revenue from Yahoo! Search fell by 18% in 4Q2011. However, without Microsoft, it would have only fallen by 6%, which would have made a great difference. Desperate attempt to restructure Yahoo s United States holdings from capital gained by selling off or reducing ownership in Asian assets that are set to decline in value. Yahoo s Asian assets are extremely valuable. Exhibit 6, which shows the value of Yahoo assets in Japan and China, indicates that 52.17% of Yahoo s current price comes from the value of its Asian assets. It can be said that its price appreciation is much driven by the excellent performance of its Asian assets. The revenue generated from these Asian assets is used to facilitate the performance and cover the losses of Yahoo s performance in US. However, Yahoo is now considering a sale of the bulk of its holdings in the Alibaba Group of China and Yahoo s Japanese affiliate back to their majority owners. If Yahoo sells all of its ownership, it would be able to have ample capital to restructure its performance in US. However, doing so would necessitate Yahoo losing its most valuable assets, which are the primarily factors that contribute to the value of Yahoo itself. Moreover, this venture is risky and likely to be wasteful as the increase in capital does not necessarily guarantee that Yahoo s development in the US will go smoothly. However, even if Yahoo keeps its holdings in Asia after reducing its ownership, the revenue generated from these Asian assets is not likely to grow steadily in the future as they are becoming less valuable. In Alibaba China, the most valuable asset is PayPal, yet since Yahoo will no longer be in control of Alibaba anymore, this would severely hurt Yahoo s ability proliferate through its Alibaba ownership. Moreover, Alibaba mainly targets start-ups and small companies to form the supplier platform in offer to earn premium from new small sized firms, yet it has recently raised the standard for a new manufacturing firm to join, elevating the required minimum capital of a firm. This new policy greatly discouraged new firms to join the Alibaba network, and the number of new stores in 2011 decreased by compared to that of Alibaba s service is also getting worse as they are receiving more claims from the Alibaba members. On the other hand, Alibaba has expanded its market to more than 100 countries, however not all of them have proven to be successful. For example, it was not able to develop its international market in Taiwan because it not only failed to gain market share from its local competitor, Wenbi Wang, but it also could not localize itself to attract local suppliers in Taiwan. For Yahoo s Asset in Japan, Yahoo! Japan has already satiated the internet market, and thus the room for its development is becoming smaller. Misperception The supposed restructuring of Yahoo to facilitate its growth in the US is merely an attempt to mitigate losses in other sectors. A lot of the analysts in the market give optimistic view on Yahoo s performance in the future after talking directly to CEO, believing that the current changes that Yahoo s going through would be able to substantially increase its margin. However, the current strategy that the management team is executing to bring back focus to its service in US does not seem feasible in the long run. In my opinion these changes are only used to cover the losses in short term, as Yahoo s management team does not seem to be changing anything substantial in terms of its core business services. The management team is even trying to sell off its assets in Asia, which are its highest revenue generating assets, in order to have ample capital to facilitate its developing in the United States, which arguably has tougher competition and a consumer base that is desensitized by Yahoo s services. VAR (See Exhibit for details) Survey: indicates the power of Google over Yahoo. Professor Siva Vaidhyanathan (Chair, Department of Media Studies): Yahoo lacks the ability to generate revenue from its core and most well-known business. Corner Interview: potential client for Yahoo s advertisement. How It Plays Out The management team will restructure United States sectors in two aspects. First, the management team will keep reducing the cost in order to improve the margin by cutting off employees and service divisions. These changes will only solve problems in the short run, because instead of innovating in other areas, it is merely cutting off various facets of its company in order mitigate losses. Second, the management team will sell or reduce Yahoo s ownership in its Asian assets, yet it is not a good option because these assets are the factors that are driving up its price. These capitals will also be lost as they are only used to cover short-term losses instead of being used to improve US performance in the long run. Risks / What Signs Would Indicate We Are Wrong? Yahoo s margin continues to grow and brings in revenue that can be used on research and development of new technology. New product development that surpasses Yahoo s competitors. Signposts / Follow-Up The next quarterly earnings report of Yahoo Selling or reduction of its ownership in Asia More lay-offs and experienced leaders leaving Yahoo. Cutting of Yahoo s core business division, in order to lower the cost. Company Description Yahoo! Inc. (YHOO) operates as a media company that delivers digital content through various devices worldwide. It offers online properties and services to users; and a range of marketing services to businesses. The company s communications and communities offerings include Yahoo! Mail, Yahoo! Messenger, Yahoo! Groups, Yahoo! Answers and Connected TV, which provide a range of communication and social services to users and businesses enabling users to organize into groups and share knowledge, common interests, and photos.

3 Exhibit 1: Stock Chart Yahoo! Inc. (YHOO) Memo Exhibit 2: Preference of Search Engine (VAR) Exhibit 3 (VAR): Interview with restaurant owners on the corner. Owner of Nihao Chinese Restaurant: I am thinking about opening another restaurant in Charlottesville area, and would probably ask Google to advertise for me online, because the representative of Google has being calling me at least once a month. Yahoo has never contacted me. Owner of Lemongrass: I don t have any plan on expanding my restaurant, but if I am I will definitely ask Google to advertise for me. I know other small restaurant owners, and none of them have asked Yahoo to advertise for them. Google is definitely the best choice, and I heard that the outcomes were very good too.

4 Exhibit 4 Exhibit 5: revenue from Search Segment Exhibit 6: Valuation of Yahoo s Asian Assets (from JP Morgan s Yahoo Update 2012/02/15) Yahoo! Japan Valuation Total Yahoo! Japan Enterprise Value $ 16, Yahoo! Stake 34.80% market value of Yahoo! Japan Stake $ 5, less 40% Discount $ 2, Discounted Value of yahoo! Japan Stake $ 3, Value of Yahoo! Japan per share $ 2.66

5 Alibaba.com Valuation Total Alibaba.com Enterprise Value $ 6, % Yahoo! Ownership 28.40% Market value of Yahoo!'s Alibaba.com Stake $ 1, Less 30% discount $ Discounted Value of Alibaba.om stake $ 1, Value of Alibaba.com per share $ 1.03 Rest of Alibaba Estimated value of remaining assets in Alibaba group $ 19, & Yahoo! Ownership 42% Market value of Yahoo!'s Alibaba.com Stake $ 7, Less 30% discount $ 2, Discounted Value of Yahoo!'s Alibaba Group stake $ 5, Value of Alibaba Group per Yahoo! Share $ 4.36 Total discounted value of Alibaba to Yahoo! $ 6, Total value per share $ 5.39