Yahoo Earnings Call Reflects Slight Hint of Desperation

Brian Bolan, research analyst at Jackson Securities, sent a note to his clients regarding Yahoo!'s (YHOO) recently released Q1 results. Key excerpts follow:

Valuation and Recommendation:

Earnings released last night will likely not excite investors and could cause many to realign their technology portfolios. Yahoo!’s earnings call seemed to have a slight hint of desperation to it, as deals with eBay (EBAY), United Online (UNTD) and Viacom (VIA) were presented as the potential saviors to what is more like a cost control problem at Yahoo!. After seeing a sell off in after hours, we remind investors that our target price of $26 implies significant de-valuation may still be on the horizon.

Earnings review

Yahoo! reported revenue of $1.183B in the first quarter of 2007, below that of both the Wall Street consensus and our estimate. A quick look at our estimates shows that we were far too aggressive as the company posted a topline number that was 3.9% below that of our estimate.

Paid relationships were up 200,000 in the quarter, bringing the total to 16.5M individuals who are paying Yahoo! for a premium service. Last quarter the increase was better than 800,000 and the drop off can be explained by the lack of fantasy football. Going forward, we expect this number to increase in 2Q07 due to fantasy baseball, and would hope to see the revenue per user per month begin to stabilize.

Project Panama launched, heads out to the rest of the world

The wait is over for Project Panama, released on February 5, the new system for ad placement is expected to reverse the current downward trend of revenue per query in search. The company again noted that it would likely take a full quarter before we would see positive financial affects of Panama, but that the second half of the year should show building results.

As of the end of March, all US advertisers had been transitioned to the new platform and the roll out now moves to the international community. As of the release of earnings, 5 select partners in Japan were introduced to the new platform and several others are expected to come on line in the coming days. The international roll out will proceed much the same way as the domestic roll out occurred.

New inventory coming and a shift seen by management

Several times throughout the prepared remarks of the conference call, management noted that there was new inventory coming online and transition or shift about to occur. We believe that they may have been referring to video on the web and the coming content war that Google seems to be fighting with Viacom. Little clarity was really given on this idea, but it is one that we will pay close attention to in the coming weeks.

The Silent Semel

This conference call was dominated by Sue Decker, as she handled nearly every question. CEO Terry Semel was barely audible and his reply to a question on the Google purchase of DoubleClick was almost a non-answer. If anything, this shows the writing is on the wall and that another quarter with a bottom line miss will be the last one for Semel. It is apparent that Decker is more than capable of stepping in at any moment.

We note that stock based compensation was significantly higher than we expected in the quarter, coming in at $140M vs. our $125M estimate. We continue to believe that stock based compensation is a highly effective way to attract and retain the highest quality of employee, but we have to begin to question management as to where this is all headed.

Some may think that the underwhelming performance of Yahoo in the quarter, accompanied by higher costs, higher stock based comp and a virtually invisible CEO on the conf call could be a sign of a change at the top in the near term. We tend to agree with this idea.

Higher costs across the board

Yahoo posted some disappointing expense numbers for the first quarter of 2007. There was also no mention of a potential cost control ahead, but rather that cash flow margins were likely to continue to fall throughout the second quarter. Management also implied that there should be a rebound, as margins for the full year should recover to the 40% levels that were present last year.

The expense front, we were surprised by the higher number in all three main line items. We are particularly worried about the growth in the General and Administration line which was fully 13% ahead of our estimate. Going forward, we will likely be increasing our Operating expense estimates to reflect this.

Guidance

Guidance was less than impressive, seeing $1.2B -$1.3B on the topline for the next quarter. For the full year, Yahoo expects revenue of between $4.95B - $5.54B, up 14% from year ago levels at the midpoint. We believe our estimates are probably too aggressive going forward and we will be adjusting our numbers downward in the coming weeks.

Valuation

We continue to believe that holding Yahoo! shares is the appropriate action given the circumstances. After seeing the stock increase dramatically over the past few months, a healthy readjustment has taken place. With the stock trading in the high 20’s again, we feel investors have realized that the super high (and somewhat unfair) expectations of Yahoo! are not realistic. We continue to rate Yahoo! shares HOLD. We will be looking deeper into the valuation of Yahoo later in the quarter.