January 11, 2001 - Merrill Lynch
Profitability - The main problem in modeling GoTo's long term operating margin is understanding its ability to leverage sales and marketing, which is currently 85% of sales and increasing to about 100% in 4Q due to the payments from the AOL deal. A significant portion of GOTO's sales and marketing dollars (we guess about 75%) are paid to affiliates for search traffic. In other words, since clickthroughs on search traffic are the company's unit of revenue, GOTO suffers from high variable costs, which limits GOTO's contribution margin.
On top of that, if GOTO variable costs are fixed dollar amount per unit rather than a
percentage of revenue per unit, if clickthroughs are going to lower bidders as described above, this will put pressure on margins.
In this regard, the true gross margin based on the cost of traffic (in S&M) plus the
telecommunications cost of supporting it (in COGS) is probably closer to 40-50%, versus
the GAAP gross margin of 85%. In other words, we would view GOTO's model as closer to DoubleClick's with 50+% gross margin, rather than a media model such as Yahoo at 85+% gross margin. We believe it will be *IMPORTANT* to watch over the next few quarters how quickly the company can grow its PIs, and at what cost-especially as there is downward pressure on revenue per click through. |
