Project Network Hunt: Yahoo!
Executive Summary
Yahoo! Inc. is a global Internet communications, commerce, and media company that both offers a branded network of services to millions of users daily and provides online business services designed to enhance it's client's Web services, including audio and video streaming, store hosting and management, and Web site tools and services.
Yahoo!'s mission is "to be the only place that anyone has to go to find and get connected to anything or anybody, with content, things to buy, and other people to communicate with-one seamless place, connecting users, information, and merchants worldwide."
Like the Internet itself, the portal industry segment is still young and beautiful. Included among its attractive features are: (a) exponential growth in traffic, membership, and e-commerce, with each, at least, doubling by 2003; (b) ability to scale business rapidly; (c) efficient Internet advertising uses data to target customers and measure results, and then builds communities around brands; (d) unusually high margins resulting from its light business model; (e) first-mover advantages that build brand awareness that extends to new services; (f) the aggregation of switching costs; and (g) rapid response time to threats or new opportunities.
According to Chairman and CEO Tim Koogle, Yahoo's management believed that if it were the successful first-mover, then it could ride the advancing wave of Internet growth until it became a comprehensive, global, branded network-business. The plan: get big fast, become the only essential, trusted place, and then make big bucks! How? Think, "network effects."
To execute on this enormous opportunity, Y! envisioned six interrelated objectives:
1. To build a large, global, branded network-business.
2. To integrate a comprehensive set of content, communication, business, and commerce services.
3. To attract, retain, and continue to grow the single largest audience.
4. To make their services, not only desirable, but also essential to the life styles of their audience.
5. To use their large audience to appeal to advertisers, content suppliers, and merchants worldwide.
6. To execute and, thus, drive a big business with truly outstanding financial returns.
Best of all, Koogle foresaw that the interrelations among the objectives would create a virtuous cycle of increasing returns that he called "self-reinforcing scale." By aggregating content under their Yahoo! brand, they could attract a large audience that, in turn, would attract informers, advertisers, and merchants that would improve the quality of the service offerings that, in turn, would attract a larger audience that, in turn, would attract more service partnerships that, in turn, would be transformed into profits and exceptional cash flows.
Thus, from the beginning, not only did Yahoo and Koogle understand the exponential power of network effects as an engine of growth and value, but also they understood the implication of network effects on a global scale: how network effects create new opportunities for local popularity that permit new winners in demand-side-first-to-scale battles. And, above all, Koogle understood the signal importance of execution.
The Gorilla Game emphasized the significance of a discontinuous innovation that creates a technology product that provides a compelling business advantage to the company whose open, but proprietary, architecture becomes the standard for a new wave of technology. There is a fundamental difference between this product-oriented approach of the Gorilla Game and the investment thesis of an Internet service provider. This key difference is that the origin of value creation for an Internet service provider is not a discontinuous product innovation, but is instead the creation itself of its innovative business model. Yahoo's business model is the wellspring of its competitive advantage.
Y!'s strategy created innovative and compelling value through a collaborative business web (see Digital Capital by Tapscott, Ticoll, & Lowy, 2000). A business web (b-web) is defined by Tapscott et al (p. 4) as "a distinct system of suppliers, distributors, commerce service providers, infrastructure providers, and customers that use the Internet for their primary business communications and transactions." A b-web is the mechanism for increasing "digital capital"-the knowledge- and relationship-based currency of the new economy of digital networks. Digital capital (p. 5) results from the internetworking of three types of knowledge assets: (a) human capital (what people know), (b) customer capital (who you know, and who knows and values you), and (c) structural capital (how what you know is built into your business system).
On 9/16/00, Richey reported that Y! got clobbered in spite of a strong quarter: revenue of 295.5 MM, up 89.6% y/y; GM of 86.2%, up from 83.2% last year; net margins of 16.1%, up from 7/1% last year; no debt and 1.6 billion in cash, up from 840 million last year; estimated Foolish Flow ratio of 0.26, down from .37 last year; Cash King Margin of 51.0%, up from 37.9% last year.
Y!'s financial figures reveal the power of its light business model: revenues in hypergrowth year over year, gross margins among the world's best, a strong balance sheet that is both free of debt and rich in cash, superior working capital management, and exceptional cash net margins that reveal its strength as an extraordinary generator of cash and cash returns. As it rides the colossal Internet wave, what drives its extraordinary performance?
The Internet is to the new millennium what Gutenberg's printing press was to the Renaissance, an agent of unparalleled, non-linear change. Two economic implications of the Internet are already clear. First, companies are decentralizing because transaction costs are dramatically lowered, approaching zero. Second, global markets are rapidly increasing in significance.
Macro drivers are explanatory forces at the systems level, including unfolding social, political, cultural, and economic trends. Last October, Koogle identified six trends shaping the evolution of the Web: (a) increasing growth in available bandwidth; (b) expanding access across multiple devices that connect to diverse types of networks; (c) expanding integration of voice, data, and video communication services; (d) a transition from distributed software products to distributed application services; (e) rapid worldwide adoption of Web-based commerce; and (f) a rapidly growing world market in terms of both users and spenders. As the Internet fosters emergent waves of social and economic change, Yahoo! rides these waves.
Last month, Elizabeth Demers and Baruch Lev reported their research on the Internet shakeout in 2000. Demers and Lev found that REACH and STICKINESS were significantly positively correlated with Price/Sales ratios, their index of stock value, in both 1999 and 2000, but LOYALTY was not associated with P/S in either year. [They used a common factor analysis, which extracts as few orthogonal factors as possible; had they factor analyzed the data to achieve a rationally predicted three-factor solution, perhaps the LOYALTY factor might have been significant. In any event, loyalty is too important as a concept to ignore.] They concluded that: (a) web traffic metrics still remain relevant to explaining the evaluation of Internet stocks in 2000; (b) technology investors distinguished between expenses and investments by capitalizing R&D and customer acquisition costs prior to the bubble bursting; (c) a proxy for "cash burn rate" was also an important value driver in 1999 and 2000; and (d) their measure of the relative over-valuation of B2C stocks in Q1Y00 was positively associated with the drop in P/S during the shakeout even after including competing explanatory variables.
In Q3, Yahoo! once again emerged as the world's leading global, branded Web network, with 166 million unique users in the month of September. Y! had 185 million cumulative registered users, According to Neilsen/NetRatings in August, the Y! network reached 60.6% of the of the combined U. S. home/work audience. Y! was ranked # 1 among work users, with a reach of 68.4%, and # 2 among home users, with a reach of 53.6%. Neilsen/NetRatings ranked Y! # 1 for time spent on site by the combined work/ home audience, with 98 minutes. According to Media Metrix latest research, among the top six Web sites, Y! is ranked # 1 in month-to-month visitor retention of 79.2%.
In fact, in the Q3 CC, Jeff Mallet reported that registered users both do more and spend more. R-users account for 55% of daily page views, four times more than non-RUs, and they click-through on twice as many ads. RUs account for 68% of enabled Shopping transaction, 70% of enabled Travel transactions, and 100% of enabled auction transactions. RU's account for 80% of the average 98 minutes spent on site. Notice not only how valuable registered users are to Y!, but also that Y! collects such valuable data.
Brand has long been recognized as a value driver. Demers and Lev could not use brand ratings in their research because very few Internet companies have established a brand name. Lev's thinking on intangible assets, however, indicates that brand is a value driver. In July 2000, the Financial Times published the 2000 (1999) International Rankings of the Values of Billion Dollar Brands by Interbrand/Citibank. Of the top 75 brands, Yahoo! had the largest percentage increase, 258%, in brand value in the last year, from 1.8BB to 6.33BB, moving it up from 53 to #38 in the rankings. Only two other Internet companies appeared in the top 75 international brands: AOL moved down from 35th to #47, increasing in brand value only 5%, from 4.3 to 4.5BB; and Amazon.com moved up from 57th place to #48, increasing a penultimate 233% percent, from 1.4 to 4.5BB.
In "Information Rules," Shapiro and Varian (1999) stated that tippy markets result from a combination of high demand- and supply-side scaling coupled with low demand for variety [i.e., with increasing standardization]. Also, dynamic-scale economics, which arise from learning-by-doing and moving up the experience curve, further amplify demand-side scaling. Yahoo! is positioned to reap these benefits of its self-reinforcing scaling, tipping one local market after another in a set of New Frontier winner-take-most games.
Yahoo! commonly extends its breadth of offerings through acquisitions. To name only a few: Yoyodyne brought internet marketing skills; WebCal brought calendar and scheduling product and a data base of public events; ViaWeb brought software and reporting tools for building and operating online commerce websites; Hyperparallel, data analysis of direct marketing; Geocities, hosting of personal web sites and themed communities; Broadcast.com, providing streamed audio and video content; eGroups, enhancing e-mail solutions, with one-to-one, many-to-one, many-to-many mailing among diverse interest groups and communities.
Y! is an open, comprehensive, integrated, worldwide ENABLER, the only essential place, the single, trusted portal for a large and growing, yet dependent, value chain. Why dependent? Because Y! has one of only two or three huge audiences in the world. Just as Y! seeks to become essential by offering crucial services to its customer-users, it seeks the same ubiquity and essentiality for its customer-businesses and -enterprises. The key is its execution in providing deeper, valued, essential services to its b-web of advertising, commerce, small business, corporate, and enterprise customers and 166 MM consumers. Every relationship is a customer relationship. Each relationship depends on providing quality services that meet the increasingly essential needs of that distinct customer, whether an individual or a business/enterprise. Y!'s business model is an Internet mass customized service model: global yet local; universal yet personal.
Without a doubt, Y! is embroiled in a controversy over its quarterly advertising revenues. What do we know? First, Y! derives 80 to 90% of its revenues from advertising. Net revenues rose a better than expected 90% in Q3. Second, analysts raised questions about the ability of financially stressed dot-com companies to maintain advertising. Third, these questions occurred in spite of the fact that 60% of its revenues came from traditional companies, up 23% from Q2, and only 40% of its advertising revenues came from dot.com companies, down from 47% in Q2. Fourth, in spite of Koogle's declaration that no more than 10% of its revenues came from companies whose finances were at risk, the Street remained scared, expecting that two to three more quarters to be effected by the dot.com meltdown. Thus, although Y! recorded better than expected revenues, and marvelous cash flow, up 415% in the last year, it still sold off.
If it can distinguish a pearl from an oyster, what the market should notice, however, is that Y! is not only very profitable but also an even better cash generating machine with no debt. Moreover, Y!'s web metrics are genuine drivers of future value. If it does not recognize these virtues, the Street's blindness creates an exploitable gap in expectations that can profit insightful long-term investors with an eye for beauty bare.
If Y! drives globalization, mobilization, and the usage of expanding bandwidth, it increases its real options as an enabler of transaction and in offering business services. What Y! has learned to do well in the U.S. can be replicated, yet made local, in its 24 worldwide locations. This is a real option to expand successful strategies and outcomes worldwide. Given the Principle of New Frontiers, sometimes you can become a winner in a niche abroad where you may not have been able to reach critical mass in the U. S. Mobilization of Y! Everywhere, not only at work or at home, but also in cars, taxis, airplanes, ships, and wherever you can carry a phone, increases essentiality-the ultimate in reach, stickiness, and loyalty. Imagine having your calendar, messages, mail, and map always available and voice-enriched. Is this a premium service? Is it a new advertising medium? And, what real options will be created by expanding bandwidth? Imagine video added to your personal communicator. Currently, Y! uses its Broadcast.com acquisition to broadcast streaming video from Silicon Valley as :FinanceVision. Yahoo! says that this is an X-vision strategy. The real options here are exciting, from FinanceVision to HealthVision to NBA-Vision to whatever.
When you have a vision of real options dancing in your head, you can appreciate the future value of becoming the single trusted place for a huge audience of users. It's better than Christmas! When you realize that Y! provides not only profits but, better yet, exciting cash flow, then you can wait patiently as Y! rapidly executes its strategic vision. According to TMF Zeke Ashton, who characterized Yahoo! as the king of expanding possibilities, " . . . the market perpetually overvalues predictability and undervalues expanding possibilities." This creates an exploitable investing opportunity. In contrast to backward-looking investors who favor "rules of thumb like P/E ratios, Ashton argued that forward looking investors can extrapolate FCF forward to 2004 by assuming that it doubles each year. If that does happen, Yahoo! garners $5.1BB in free cash flow. And, Y! has no debt because of its tremendous cash flow and its exceptional return on cash invested in new operations. Yes, these extraordinary financials and Y!'s management create endless real options for a global communications, commerce, and media enterprise using an Internet platform. Yes, Virginia, there is a Santa Claus.
I hope this not so brief summary helps. Or, I will have to summarize my summary. (gg) The full report is divided into three parts, on strategy, execution, and making money.
Don |
