You Shouldn't Buy These Internet Stocks Despite Market Optimism

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

The upswing in the usage of smartphones and tablets has taken the "Global Digital Advertising" industry to a different paradigm. According to the research firm eMarketer, global digital advertising spending for 2012 totaled $100 billion, and is expected to increase 15% in 2013.

In this article, I have picked up three players YahooBaidu (NASDAQ: BIDU) and AOL (NYSE: AOL) that have benefited in the past by the Digital Ad industry and are strategically placed to monetize this upsurge in digital ad spending. I am analyzing these stocks on the basis of how they have performed in the last quarters and what could be their future endeavors.

Yahoo! Incorporated

The company's 4Q12 results gave me mixed feelings. Sales from the Display ad segment continued to contract, as it fell by ~5% y/y. On the other hand, its revenue was up by ~4% y/y because of the rise in search and other revenues. Moving into the future, I don't see a massive upside in this stock, although the deal with Google (NASDAQ: GOOG) and the positives of Yahoo Japan's valuation may give some tailwinds to it.

With the latest deal between Yahoo and Google, the company has entered into a non-exclusive agreement with Google to display ads on Yahoo properties across the desktop and mobile platforms. The ads will be displayed using Google's AdSense for Content and AdMob services. I see two benefits from this deal. One, the partnership essentially makes Yahoo a large publisher for Google's content network; and secondly, it should help it in improving the monetization ability of its class two display inventory. The effect of this partnership will show results in 2Q13. However, I don't think it is going to have any major value impact for the company as it has the potential to add only ~$24 million to Yahoo's net Display revenue. However, the deepening relationship between the two Internet and digital Media companies raises the possibility of Google replacing Microsoft to manage Yahoo's search ad business.

On the other side, recently Yahoo Japan released its earnings covering the December quarter. Since then, its stock price has seen more than a 30% hike. The market-based pricing for Yahoo Japan, an asset in which the company holds ~35% stake; will help Yahoo to post stronger balance sheet. However, the weakening position of the Yen will reduce the overall value of the investment.

Hence, even though the Google deal and investment in Yahoo Japan will have positive financial impact on Yahoo, but an extraordinary price rise cannot be expected from the stock. Keeping this in mind, I don't see an investing opportunity in this stock for now.

Baidu, Inc.

When a company holds ~79% share in a country's PC search market, the investor's expectation from the quarterly results don't work the same way as they do for other internet companies. Same thing happened to Baidu when its stock price fell ~10% after the declaration of its 4Q12 results. The company's operating margin for the period was ~46% which was ~14% lesser than its last quarter's margin. Also, this was the lowest profit increase since 2009. The key reasons for decrease in the profitability were:

1. Operational loss of iQiyi: The one-month consolidation after iQiyi's acquisition negatively affected margins. Although it contributed in increasing the total revenue, the operating loss from iQiyi was ~$10 million for December, 2012.

2. Higher TAC and selling cost: Traffic acquisition costs (TAC) increased to 9.6%. Selling costs were up due to the increasing hao123 promotional traffic and the continued aggressive push on mobile distribution channel fees for its mobile apps installation.

Baidu's target for the next 12 months is to increase traffic for both short-term and long-term purposes. However, I see 2 hurdles in it. In the short-term Baidu will face stiff competition from Qihoo (NYSE: QIHU) that captured ~6% traffic from the company. Long-term pressure on traffic is likely anticipated from the usage shift from PC to mobile. According to the CNZZ's report, China's PC traffic dropped in 4Q12 due to the mobile Internet competition. I expect that this shift will affect the profitability of the company as mobile monetization involves less ad inventory and lower cost-per-click rates.

Going forward, Baidu's plans on providing third-party tools to help the app developers offer great appeal to users. And, the plans to foster a large mobile community includes lavish content, and information to enhance the user's dependence on its services. I appreciate Baidu's strategy of investing in the future, but these investment programs will take a long time to show results and hence, don't help the volatility of the stock in the near future. Looking at these factors, I suggest a hold on Baidu unless I see any stability in future.

AOL Incorporated

The 4Q12 results were a bit different for the company as this time it had some added positive sentiments attached to it. For the first time in the last eight years, AOL posted growth in its revenue that stood at ~$600 million, far ahead of the consensus expectation of ~$574 million. This growth was mainly due to the rise in the Search segment and AOL's Third-Party Network. AOL's new segment reporting revealed that, a major chunk of the company's profitability came from its Membership Group, more specifically subscription revenue. AOL further reduced its outstanding shares by ~14.4 million in the quarter, bringing the total shares down by almost 20% over the course of 2012. The management further announced an added ~$100 million share repurchase authorization for 2013.

Going forward, the company's focus will be on closing the mobile monetization gap. The company has ~40 million unique visitors on mobile and is concentrating new ad formats and improved targeting. Another key area of focus will be the changing industry as it moves into a multi-screen environment. The unique IDs become important to track users as they move between mobile and desktop. It is working on a universal ID registration process to allow users to enjoy a seamless experience across different platforms.

Finally, I also expect a saving of $190 million in corporate expenses over time as it cleans out the legacy issues, which can help it to fuel the continued income growth. I am bullish on AOL and feel this is the right time to buy this stock.

Investor's Take Away

I think Yahoo and Baidu should be a "hold" for now as the near-term scenario of these two companies are a bit foggy. Yahoo with its depleting display visitors and fall in earnings has seen some volatility, but the news of its deal with Google has helped the stock to stabilize. For Baidu, the fall in this stock with slower growth doesn't give me confidence in this stock for now. Although, I feel that the company has potential for capturing the continuously increasing Chinese mobile monetization market, I would recommend the investors to wait on this stock till something concrete comes up. On the other hand, AOL with its strong quarter has raised hopes for the future. The stock buyback plan in 2013 and initiatives to close the mobile monetization gap can help the upside for this stock


ShwetaDubey has no position in any stocks mentioned. The Motley Fool owns shares of Tupperware Brands and has the following options: Long Jan 2014 $50 Calls on Herbalife Ltd.. 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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