Surviving the Search Wars

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

Internet searches have become an indispensable part of life, helping people to find everything much quicker and more efficiently than in the past.  Google (NASDAQ: GOOG) has built a $200 billion empire in just 10 years through its dominance of the search business, although it has expanded to a variety of technology segments.  Data provider comScore estimates that Google held a 67% market share recently, versus 16.0% for Microsoft (NASDAQ: MSFT) and 12.2% for Yahoo (NASDAQ: YHOO).  After finally seeing the writing on the wall, Yahoo raised the white flag a few years ago and partnered with Microsoft for the generation of search results based on its Bing technology.

Google's initial business strength was its superior search engine that produced more relevant results and allowed users to find information faster than other websites.  Users also preferred the simplicity of the company's homepage, which has no advertising and a whole lot of white space surrounding the search bar.  In FY2012, the company has continued to produce strong results, with increases in revenues and operating income of 35.3% and 13.3%, respectively, versus the prior year period.  The large profits from the search business have led to a large cash position, which Google has used to buy or build leading positions in email, video, and e-commerce applications.  While Microsoft's Bing technology has improved the output of search results for itself and Yahoo, nobody is likely to displace Google from its industry leadership position.

Looking Beyond the Googleplex

Are there investment opportunities in the online search business beyond the industry's titan.  Yes, but you need to look for companies that are partners, rather than direct competitors to Google.  Founded in 1996, Blucora (NASDAQ: BCOR) was one of the early consumer web companies and operates a number of company-owned websites, including and  However, persistent operating losses after the 2000 dotcom meltdown caused management to shift corporate strategy and reposition the company as an aggregator of search results from third party providers.  Over 95% of Blucora’s search revenues are now generated by third party companies, primarily Google and Yahoo, which the company delivers to its distribution partners’ websites.

In its latest fiscal year, Blucora reported revenues and adjusted EBITDA of $228.8 million and $36.6 million, increases of 6.8% and 12.8%, respectively, over the prior year.  The company’s own web properties experienced declines in search activity and revenues, but these results were more than offset by a 23.6% increase in revenues from searches on its distribution partners’ websites.  While the revenue sharing of the aggregation business model led to a decline in gross margins, the elimination of customer acquisition costs and overhead led to the highest operating margin of the past five years.

Diversifying the Biz

In January 2012, Blucora decided to put its $300 million cash hoard to good use and purchased the owner of TaxACT for roughly $288 million in cash.  The acquisition diversified the company’s revenue streams and reduced the risk of an overreliance on Google and Yahoo search results.  TaxACT is a leading provider of income tax preparation software and related services to the domestic market.  Its basic service is “free” for federal filings, while users can upgrade to higher service levels at various price points.  The IRS has been a strong proponent of e-filing and reported that 83% of total processed returns were electronically filed in 2012.

Looking Ahead

In the first nine months of FY2012, Blucora reported increases in revenues and adjusted EBITDA of 90.8% and 158.2%, respectively, compared to the prior year period.  The company’s growth benefited from its acquisition of TaxACT, as well as a 53.2% increase in its search revenues.  While gross margins in the search unit continued to decline, company-wide gross and operating margins rose due to the higher profitability of the tax preparation business.  The acquisition looks like a winner at this point, with the tax prep segment contributing $32.5 million in profits through the first nine months of the year.  Despite tough competition from Intuit and H&R Block, the company's strong operating cash flows and balance sheet will allow it to compete successfully over the long term.  It also has a valuable asset in its $800 million of prior operating losses that will shield it against future taxes and may be of interest to potential acquirers.  Blucora is carving its own niche in the internet world and investors should put this one on the watchlist.

rghanley owns shares of Yahoo and Blucora. The Motley Fool owns shares of Google and Microsoft. Motley Fool newsletter services recommend 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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