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Thursday, September 17, 2009

Yahoo! Again Embraced by Wall Street - Online Real Estate is Valuable

Yahoo! (YHOO, $17.50) is rallying on renewed love from Wall Street -- Sanford C. Bernstein upgraded the stock Tuesday to "Outperform" and Barclays raised estimates/target today.

Although we recently lightened up on our Yahoo! position to reallocate some capital (full disclosure), we still hold shares and believe the franchise is extremely difficult to replicate. Last November, we shared the following with family/friends:
  • Briefly, on YHOO – with headlines such as “What’s Yahoo Going to Do?” and “Yahoo Is Finished and Must Sell!”, the media brouhaha over Microsoft is ridiculous. Seemingly lost in the mix is that Yahoo! is one of the premier Internet franchises in the world, with almost as much traffic as Google (source: comScore), the most popular email platform (comScore), and – believe it or not – the most popular sports portal (ahead of espn.com, per BusinessWeek / Yahoo). Yes, the advertising world is hurting because of the recession and Yahoo’s outlook may remain under pressure; yes, Google’s search offering is a highly effective, killer business; and, yes, results have been lackluster. Yet, the company has been investing in many areas (e.g.: ad exchange platform, video, mobile) that have crimped margins but should bear much fruit over medium term, especially when the economy turns the corner. Further, the company has no debt, generates plenty of free cash flow, and has more than $2 per share of cash on the balance sheet plus Asian properties worth perhaps $4-5 per share. This analysis suggests investors can buy Yahoo’s core business for just $4-5 per share, which appears an incredible bargain. Bottom-line: Yahoo owns an Internet franchise/brand that is impossible to replicate and that should only become more valuable with time as prime online real estate appreciates in value. I recently purchased more shares in the mid $9s.
Although shares are now substantially higher than last fall, we believe the above thesis still holds, albeit with numbers shifted around, e.g. cash per share now $2.77 and different values for Asian assets, plus business model questions related to the search deal with Microsoft (MSFT, $25.30). We continue to see significant franchise value for Yahoo! and expect incremental upside over time.

As additional fodder supporting the franchise, let's briefly look at information included in a recent Forbes cover story "Can Yahoo's Carol Bartz Outsmart Microsoft And Google?":
  • [Yahoo has the] ability to reach 500 million-plus people in 30 countries, putting ads in front of them all.
  • Yahoo Mail has 98 million users in the U.S. alone, almost three times as many as Microsoft's Windows Live e-mail and four times as many as Gmail from Google.
  • Yahoo News claims six times as many readers as the four highest-circulation dailies combined.
  • Three million photos a day go onto its Flickr photo service.
  • Two hundred and sixty million ads a month are submitted to Yahoo, and 20 million are manually reviewed for content. Six million are rejected for inappropriate content.
Thus, the company is well-placed to remain a dominant Internet/media player.

Still, despite our positive view of the franchise, there are some areas of concern for investors: (1) Internet dynamics/technology change quickly and traffic monetization is not a slam dunk (have Yahoo!'s many acquisitions [under prior management] been accretive or destructive for shareholders?), (2) the law of large numbers could yield only moderate top- and bottom-line growth for the company once the economy turns, and (3) excluding hidden assets (e.g. Asian assets), shares of Yahoo! currently offer a TTM free cash flow yield of only 3% and shares may remain expensive on a P/E basis for years to come (currently 44 times consensus 2010 estimate of $0.40). With respect to the last point, we're willing to cut a bit of slack given franchise characteristics that support sizable economic goodwill.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long YHOO.

© 2009 Jeffrey Walkenhorst
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