Is This Search Giant Back on Track?

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

Yahoo! (NASDAQ: YHOO) recently reported its first quarter earnings, which showed double-digit growth in profit on a decline in revenue. Under the leadership of CEO Marissa Mayer, Yahoo! has made significant improvements since the dark days of Carol Bartz, when the company failed to formulate an effective counter strategy against Google (NASDAQ: GOOG) and Facebook (NASDAQ: FB), instead opting to sell itself off piece by piece. But are Yahoo!’s first quarter numbers indicative of a continuing growth trend, even after the stock has risen nearly 60% over the past twelve months?

First quarter

For its first quarter, Yahoo! earned an adjusted $0.38 per share, up from the $0.24 it earned in the prior year quarter. Revenue declined 7% from $1.22 billion to $1.14 billion. Analysts polled by Thomson Reuters were expecting Yahoo! to earn $0.24 per share on $1.10 billion in revenue.

Yahoo!’s search revenue rose 6% to $384 million, but advertising revenue was fairly weak, declining 3%. Display advertising revenues slid 11% to $402 million, and price-per-click, a key metric for Internet advertising, slid 7%. However, revenue from ads running with search results rose 6% from the prior year quarter. These numbers seem to indicate that Yahoo! is growing as a search engine, and it just needs to monetize its advertisements better.

Yahoo!’s stakes in Chinese Internet giant Alibaba and Yahoo! Japan also paid off, generating $217.5 million in profit, exceeding Yahoo!’s core business profit of $186 million.

Market share

However, a look at year-over-year gains in search engine market share from the top three U.S. search engines - Google, Microsoft's (NASDAQ: MSFT) Bing and Yahoo! reveals a tough uphill battle for Yahoo!.

<table> <tbody> <tr> <td> <p><span><span><span><strong>U.S. Search Engine Market</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>March 2012</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>March 2013</strong></span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span>Google</span></span></span></p> </td> <td> <p><span><span><span>66.4%</span></span></span></p> </td> <td> <p><span><span><span>67.1%</span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span>Microsoft Bing</span></span></span></p> </td> <td> <p><span><span><span>15.3%</span></span></span></p> </td> <td> <p><span><span><span>16.9%</span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span>Yahoo!</span></span></span></p> </td> <td> <p><span><span><span>13.7%</span></span></span></p> </td> <td> <p><span><span><span>11.8%</span></span></span></p> </td> </tr> </tbody> </table>

Source: comScore

On a monthly basis, Google’s share slightly declined from February, dropping 40 basis points from 67.5%. Meanwhile, Bing was able to gain 20 basis points from 16.7%, and Yahoo! rose 20 basis points from 11.6%. Meanwhile, smaller players such as Ask.com and AOL finished March with 2.7% and 1.6% of the market, respectively. In other words, when Google slips, its crumbs trickle down to the smaller players.

What concerns me about Yahoo! is that the entirety of its business comprises its search engine and advertising business, much like how Google was before it built up its ecosystem and defensive moat. For Microsoft, Bing only comprises a tiny part of its revenue, which is primarily generated by Windows and Office license sales. Therefore, since Google is the market leader, it has more pricing power than Yahoo!, and Microsoft can afford to sell ads at lower prices, since its stake in search is a strategic one, not a profit-centered one.

Smarter expansions

I believe that Mayer is well aware of this dilemma, which has led her to make several “acqui-hires” (small acquisitions aimed at boosting its portfolio and talent pool) since taking the helm. These include Propeld and Stamped, which are local recommendation apps, Snip.it, a Pinterest-like social news site, and OnTheAir, a video chat app.

Last month, Yahoo! acquired 17-year old Nick D’Aloisio’s news aggregator app Summly for $30 million in cash and stock. The news aggregator app collects data from various online sources and compiles them into a single reader on a mobile device. What makes Summly stand out from similar products such as the Google News app is its usage of a special algorithm that shortens and summarizes longer stories into clips that can be read on the go. Yahoo! plans to use Summly’s algorithm to enhance its own mobile apps.

Since Mayer was one of the chief architects of Google’s ecosystem, it stands to reason that she realizes that Yahoo! needs a unified ecosystem of its own, and not simply a portal website, to remain competitive with Google. Google’s services, such as YouTube, Google+, Gmail and Docs, are cohesively connected. Yahoo!, meanwhile, feels more like an online magazine or newspaper than a search engine or cloud-based ecosystem.

Since Internet users are increasingly shifting to mobile platforms such as smartphones and tablets, Yahoo! needs attractive features to renew its mobile app, such as location-based recommendations and streamlined news aggregators. Mayer’s strategy centers around building a mobile ecosystem to drive advertising revenue, similar to how Google used Android to generate search traffic.

Mayer’s strategy of more focused purchases is a vast improvement over the company’s previous strategy of acquiring dozens of overpriced startups. Between September 1997 and April 2011, Yahoo! acquired a total of 64 companies, paying big premiums for many of them, such as $5.7 billion for Broadcast.com and $432 million for eGroups. That reckless tactic, where Yahoo! would buy first and then decide where to integrate later, resulted in a confused, divided strategy that allowed Google to steal away its market share.

Social media and mobile advertising

While Google is Yahoo!’s main problem, Facebook is also another thorn in its side. Facebook’s rapid growth in mobile advertisements should be a major concern for Yahoo! investors. After all, Yahoo! only reported $125 million in mobile advertising revenue in 2012.

Research firm eMarketer reveals that Facebook’s mobile ad revenue, which was non-existent in 2011, rose to $390.9 million by the end of 2012. That number is expected to soar 146.8% to $964.9 million by the end of 2013. By comparison, Google generated $750 million in mobile ad revenue in 2011, $2.17 billion in 2012, and is expected to rise 83.5% to $3.98 billion by the end of 2013.

As seen in the following chart, mobile ads aren’t that important yet, but with the imminent decline of the PC industry, I believe that the line between mobile advertising and the other categories will be blurred in the coming years.

<img alt="" height="298px;" src="https://lh6.googleusercontent.com/w1gzn0EuZCpqNFOwbpEw7chNwCGe7HPg4gAIaNeqdpz_6DXDD8r1TyIpLFz6ua41zQGXXHJSkZ1csCyUtjqn2HhnzoRdz_JxHaa7jLNFCcgHRkOqaDIVg3RH" width="600px;" />

Source: IAB, PwC

In addition, the recent release of Facebook Home for Android devices could shake things up quite a bit for both Google and Yahoo!, since the home screen launcher replacement is aimed at taking over smartphones in an effort to give Facebook a larger canvas for displaying mobile advertisements.

The Foolish Bottom Line

Mayer’s Yahoo! is still a turnaround story in the making. Yahoo! managed to break a four year long streak of consecutive annual losses last year, and is just now getting back on track with more focused long-term goals. Under Jerry Yang and Carol Bartz Yahoo! lacked focus, first spending too much and then trying to burn the furniture to stay afloat.

Yahoo! will likely have problems in the short term, as investors bemoan declining advertising revenues, but I believe that all of Mayer’s acquisitions will be drawn together later this year to wrap its desktop and mobile sites into a more cohesive, enhanced package. When that time comes, it might just be Yahoo!’s turn to finally shine again.


Leo Sun owns shares of Facebook. The Motley Fool recommends Facebook and Google. The Motley Fool owns shares of Facebook, Google, and Microsoft. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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