Is This Search Engine a Buy?

Alvin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In its most recent quarter, Yahoo! (NASDAQ: YHOO) posted a non-GAAP EPS of $0.35 (diluted). The non-GAAP EPS excludes a $2.8 billion net gain from Yahoo’s sale of its Alibaba shares and $16 million in restructuring costs (net of taxes). In comparison, in Q3 2011, the company posted a non-GAAP EPS of $0.21. That is an increase of 67% year over year. Additionally, the company strengthened its cash position. At the end of the quarter, the company had cash and cash equivalents of about $7.6 billion. In Q2 2012, the company had cash and cash equivalents of about $1.5 billion.

Overall, it was definitely a solid quarter. However, the 67% increase year over year in non-GAAP EPS is inflated. Ken Goldman, CFO, stated in the earnings call, “Stepping down the income statement, the company was able to realize certain foreign tax credits in 3Q that improved net income by $135 million. This resulted in a negative effective tax rate in the quarter, excluding the Alibaba gain” (seekingalpha). Excluding the $135 million of net income, the company would have posted a non-GAAP EPS of $0.24. It is a more modest increase of 14% year over year.

Looking forward, Marissa Mayer, CEO, plans on avoiding big acquisitions and succeeding through Yahoo’s current assets. Mayer stated in the call, “In my history and my career, I’ve done about 20 or so such acquisitions, and I think that the size and scale that’s comfortable for a great integration...is something that’s much more in the size and scale of double-digit millions and low hundreds of millions.” This is good news for investors. Large acquisitions are risky. Hewlett-Packard is a textbook example of a company that wasted billions of dollars on failed acquisitions.

Mayer’s plan of focusing on Yahoo’s current assets is a good strategy. Currently, Yahoo is one of the most visited websites in the world. According to alexa.com, yahoo.com has a global rank of number four. However, Yahoo is underutilizing its asset. The following table shows unique page views per user for the top five most trafficked websites in the world (alexa.com).

<table> <tbody> <tr> <td>Overall Rank</td> <td>Website</td> <td><span>Daily Unique Page Views/User (3 month average)</span></td> </tr> <tr> <td>1</td> <td><strong>Google</strong> <span class="ticker" data-id="203768">(NASDAQ: <a href="http://caps.fool.com/Ticker/GOOG.aspx">GOOG</a>)</span></td> <td>12.98</td> </tr> <tr> <td>2</td> <td><strong><span>Facebook</span></strong> <span class="ticker" data-id="273426">(NASDAQ: <a href="http://caps.fool.com/Ticker/FB.aspx">FB</a>)</span></td> <td>16.33</td> </tr> <tr> <td>3</td> <td><span>YouTube</span></td> <td>12.48</td> </tr> <tr> <td>4</td> <td>Yahoo!</td> <td>6.61</td> </tr> <tr> <td>5</td> <td><strong><span>Baidu</span></strong> <span class="ticker" data-id="206441">(NASDAQ: <a href="http://caps.fool.com/Ticker/BIDU.aspx">BIDU</a>)</span></td> <td>14.33</td> </tr> </tbody> </table>

As shown, Yahoo significantly under performs its competitors by around a factor of two. Google, Facebook, YouTube, and Baidu are in double figures while Yahoo is below 10. However, these other websites do have very engaging purposes. Google and Baidu are search engines, Facebook is a social networking site, and YouTube is an online video sharing site. However, Yahoo shares similar functions as Google, Baidu, and Facebook (exception YouTube). Yahoo has a search engine like Baidu and Google, and has chat and games like Facebook. Yahoo Japan has a three month average of 18.02 page views per user. Thus, Yahoo is clearly performing way below its capability.

Currently, Microsoft's (NASDAQ: MSFT) Bing powers the Yahoo search engine, but the partnership has not really done anything for either company. They are both being crushed by Google. In desktops, Google, Yahoo, Bing, and Baidu have global market shares of 84.39%, 7.58%, 4.33%, and 1.74%, respectively. In mobile devices, Google, Yahoo, Bing, and Baidu have global market shares of 91.6%, 5%, 1.26%, and 0.87%, respectively (netmarketshare). Frankly, it is a waste of money (as Microsoft knows) to try and beat Google in search. Launching a frontal assault on a superior enemy’s strongest position is almost always a terrible plan. Thus, the main blemish in Mayer’s plan for Yahoo is that one of her main goals is to compete in search. In the call, Mayer talked about reshaping Yahoo search and that she sees upside in search. This goal would most likely result in wasted resources. Fighting Google in search is a bad idea.

Regardless, there is definitely huge potential in Yahoo. It is in the top five of the most trafficked websites in the world. If Yahoo can raise its page views per user to the same level as its peers, it should unleash tremendous value. In the quarter, the company reported a solid performance and significantly improved its cash position. However, Mayer has only been in Yahoo for less than a year and she presented a general plan that includes a main goal of fighting in search. Google has crushed every opponent in search so this is a bad idea. Thus, it is difficult to make a call on Yahoo. As a result, Yahoo is a hold for the next few quarters.

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Alvin owns shares of Microsoft. The Motley Fool owns shares of Baidu, Facebook, Google, and Microsoft and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Baidu, Facebook, Google, Microsoft, and Yahoo!. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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