Project Network Hunt Report: Yahoo! (YHOO), Part II
Basic Financial Facts
Y! has 549.5 million shares outstanding (with a float of 252.7 million shares) and a market cap of about 30 billion dollars.
On 7/17/00, TMF Matt Richey reported that the Q2 CC revealed that Yahoo generated about $120 MM in free cash flow, about 65% greater than its $74 MM in pro forma earnings. Free cash flow is defined as operating cash flow minus capital expenditures. Four factors account for Yahoo's superior cash economics: (a) deferred revenues because cash payments from long-term contracts, which average 225 days are paid up front; (b) moreover, there is zero DIO, and Yahoo practices efficient cash management, reducing its already outstanding DSO from 24 to 23 days, the 17th straight quarterly improvement; (c) the tax shield on exercised employee stock options adds to the cash flow, and (d) the business requires very low and stable capital expenditures leaving cash flow relatively untouched. Yahoo's spectacular FCF-millions flowing in, very little cash flowing out-- makes you want to shout, "Yahoo!"
In addition, Yahoo's cash-return-on-cash-invested in operations is staggering. Yahoo is busy rolling out new global properties, like Yahoo! Mexico, Argentina, and India as it also invests in new services, such as its Corporate Yahoo!. How much cash is generated for each dollar invested in its operating business? Operating cash margin is FCF minus any interest income divided by non-cash assets. To determine operating cash flow, subtract interest income from FCF, that is, subtract Yahoo's interest income, $18.4 MM from its FCF to discover that its Q2 operating free cash flow was $101.6 MM. This forms the numerator. To find the denominator, Richey subtracted cash and long-term investments from total assets to calculate non-cash assets of $390.1 MM. This denominator, non-cash assets was then divided into operating free cash flow to find the operating cash ratio for Q2, which was .26. To annualize, .26 was multiplied by 4, which meant that Yahoo's extraordinary running cash-on-cash profitability exceeded 100%. Recall the opening teaser: that is how you get two bucks back in FCF for each dollar invested in operations!
Andrew Chan's analysis of Q2 found: an improvement in cash conversion cycle, from minus 14 days to minus 16.6 days Q/Q; a decrease in its already low flow ratio, from .34 to .24 Q/Q; and an ROIC improvement fromQ1's 40.8% to 51.0% for the first six months (last three years: 51.2%, 58.6%, and 55.3%).
On 9/11/00, Richey calculated Yahoo's Rule Maker metrics (trailing 12 months): Sales Growth = 119.1%; Gross Margin = 85.1%; Net Margin = 23.7%;
Cash & Marketable Securities = 1.6 billion; no debt; Foolish Flow Ratio = 0.34;
Cash King (net cash) Margin = 44.2%.
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?
Macro Drivers of the World Wide Web
In only five years, the Internet sector became the third largest technology sector by market value and the second leading technology sector in terms of wealth creation. These amazing results should alert investors that it is crucially important to analyze and understand what is going on here so you can learn how to take advantage of it.
The Internet is to the new millennium what Gutenberg's printing press was to the Renaissance, an agent of unparalleled, non-linear change. Just as the ascent of humankind required the development of speech, then of writing and the printing of books, it now blossoms under the aegis of worldwide communication from anyone to anyone, anywhere, at any time. Just as the birth of printing press sparked the Renaissance that nurtured art and science, the birth of the Internet nurtures the spread of decentralized knowledge worldwide, spreading democracy and enhancing human freedom.
Understanding who we are as humankind now requires that we turn to the Internet, to understand it as the social phenomenon that will impress its mark on this third thousand years. If investors hope to profit from this sea change, they must discover or invent explanations of the unfolding social phenomenon of the Internet, its startling proliferation, and its economic consequences.
Two economic implications of the Internet are already clear. First, companies are decentralizing because transaction costs are dramatically lowered, approaching zero. Plummeting transaction costs require the outsourcing of all functions that are not core. Core functions directly contribute to increasing competitive advantages that drive shareholder value. Large traditional industrial companies suffered from a scarcity of information. Scarce information required emphasizing hierarchical control, a chain of command that ensured efficiency. A decentralized knowledge company, however, distributes its decision making horizontally, giving it many distributed agents the freedom to adapt overall strategy to satisfy local customers when presented with unfolding opportunities in newly emergent niches. Adaptation, not efficiency, winnows the chaff from the wheat.
Second, global markets are rapidly increasing in significance. Currently, 20% of the world's gross domestic product, 6 trillion dollars, is produced and consumed in global markets. Within 30 years, 80% of the 90 trillion-plus in output will be consumed in global markets. Global markets are predicted to grow at double the rate of the growth in world domestic output. With both democracy and deregulation increasing, the accelerating surge in technology will increasingly integrate world markets. According to Michael Mauboussin, ". . . leading companies of the future will have the best the world has to offer: talented labor, large customer markets, the latest technology, the most efficient suppliers." Yahoo's strategy is designed to exploit such rare, once in a millennium, advantages. An emergent worldwide Internet means not only that a global strategy is possible, but also that it has become a necessity.
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. Koogle intends for Yahoo to extend its already strong position by further exploiting these worldwide social and economic trends. As the Internet fosters emergent waves of social and economic change, Yahoo! rides these waves.
Web Metrics Drive Value
Last month, Elizabeth Demers and Baruch Lev reported their research on the Internet shakeout in 2000. They explored the major value-drivers of B2C Internet companies' share prices both before and after the "bursting of the Internet bubble." Of interest here are their results on Web traffic measures.
Demers and Lev presented the results of a factor analysis of quarterly Web traffic measures in the Nielsen/Netrating's database for their Internet sample. A factor analysis of that data extracted three orthogonal factors: (a) REACH, (b) STICKINESS, and (c) LOYALTY. Reach is defined as the number of unique individual who visit a site, when stated as a percentage of the websurfing population. Reach is the index most frequently cited by the press; reach is an indication of the scale of the web site's base of users, of how successful the site has been in attracting visitors. Website "stickiness" is the ability to retain a user at a site for a period of time. Advertisers value "stickiness" because it implies that, given more time at the site, users are more likely to be influenced. Customer loyalty is an index of the number of repeat visits made to the site. The ability of a site to re-attract current visitors is seen as necessary to sustain its value or to grow to critical mass. This is so, for example, because it is orders from repeat customers that account for 76% of sales at Amazon.com. Both stickiness and loyalty demonstrate the user has more than a passing interest in the site, which might be generated by a special event like the Olympics, a one-time sales promotion, or the like. Superior stickiness and loyalty demonstrate the power of a company's brand, another important driver of market value.
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.
Yahoo!'s Web Metrics
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%.
For August, Media Metrix found that Y! emerged as the # 1 network in both Europe and Japan. In Japan, Y!'s daily page views increased to 112-million page view per day in September, up from 82-million in June. Y! Europe increased to 41-million daily page views in September. All of the Web figures for Japan and Europe are include in Y!'s totals.
As a comparison to top competitors, consider some July and August figures. In the U.S. in July, yahoo.com had a national reach of 63.7%; aol.com had 56.2%, msn.com had 50.2%; (geocities.com had 37.6%); lycos.com had 25.3%; altavista.com had 25.0%; excite.com had 21.3%. In August, using Neilsen/NetRatings, Y! had a global audience of 66 million; AOL had 62 million; and MSN 50 million. There are monthly fluctuations in these data, but the top three are far above other competitors.
In September, Y!'s communication platform delivered 6.1 billion messages, which was up from 4.4 billion messages in June and up from 3.6 billion in March; whereas, voice minutes grew to one billion in September , up from 500 million in June; and streamed audio and video grew to 15 billion hours, up from 13 million hours.
These Web metrics indicate that that Y! continues to grow its reach, stickiness, and loyalty. And, these variables are value drivers. Also significant is the reach and time spent on Y!'s site by individuals at work. At work, Y! has a competitive advantage that it is moving to exploit with its Corporate Yahoo! program.
Given that we now know that web metrics drive value, what can we learn from the following Table of Web Metrics and Revenues?
Table 1: Web Metrics and Revenues
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99Q1 99Q2 99Q3 99Q4 00Q1 00Q2 00Q3
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Unique Users (in MM) 60 80 105 125 145 156 166
Seq. Growth 20% 33% 31% 14% 21% 8% 6%
Registered Users 47 65 80 100 125 155 185
Seq. Growth 34% 38% 23% 25% 25% 24% 19%
Ave. Daily Page Views 235 310 385 465 625 680 780
Seq. Growth 41% 32% 24% 21% 34% 9% 15%
Revenue ($M) 104 129 155 201 228 270 296
Seq. Growth 25% 24%
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First, overall, on their face, the Web metrics given in millions, the sequential (and implicit year to year) growth rates, and the associated rise in revenues are impressive. These figures also can be used to track the direction of future results, whether Y!'s sequential growth can remain in double digits. However, it appears possible that the period of hypergrowth, 100% year-to-year growth, may be slowing or even ending. However, the last Q's new data point is not sufficient to establish such a trend, particularly since it reflects the bursting of the Internet "bubble," with its associated slow down in advertising by financially distressed dot.coms.
Today's unique users are a leading indicator of tomorrow's revenues. Of course, the rate of acceleration of international users has less impact on advertisers in the U.S. where the user base is already huge. Yahoo's growth in unique users is becoming more dependent on the growth of international Web traffic, which is rapidly growing but also currently returns less revenues to Y!. Of course, Japan is not included in Y!'s revenues because its primary owner is Softbank. Y! owns 34% of Yahoo! Japan, and Softbank owns 27% of Yahoo!.
Second, the growth in registered users is even more rapid and now larger than the growth in unique users. Registered users are repeat users, both sticky and loyal who are liable to continue to extend their use into Y!'s expanding services. These users are a particularly valuable resource because registration not only indicates that the user has chosen to enroll in a personalized service, like e-mail or bill payment, but also that the registration process adds to the Y!'s data base that is useful for targeting audiences by advertisers. For this source of competitive advantage, Y! uses a one-time universal registration for all of its premium services. Thus, growth in registered users is even more promising as a leading indicator of revenues than growth in unique users.
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.
Third, although both new users and repeat users contribute to the number of average daily page views, when it is the registered users who are using more pages, their increased usage indicates that Y! is becoming essential in their lives. The significance of this is discussed further below as an aspect of branding and as a source of new revenues.
Yahoo!'s Brand as a Value Driver
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.
Yahoo! is a living room brand name, with worldwide recognition. Yahoo! wants to brand its name and link it to its mantra, "the only place you have to go to find anything, connect to anyone, or to buy anything." Y! wants hearing or seeing the brand name "Yahoo!" spontaneously to evoke the automatic response, "the only place you have to go, etc." Branding is not achieved by mere advertising; instead, brand value is earned. Strategically, Y! wants it brand to mean: a single comprehensive and trusted place that offer choices made easy because of its rapid innovation in services.
From the perspective of the TMF Rule Maker qualitative criteria, Y! is: (a) the dominant brand with pervasive mindshare; (b) a repeat-purchase business, the only place you have to go day after day; (c) convenient, access in only mouse clicks away; and (d) full of expanding possibilities because its future promises more enticing opportunities than its already generously rewarding past. As a brand name, "Yahoo!" is familiar, open, optimistic, legitimate, inevitable, dominant, and humorous. We all say, "Yahoo!"
Driving Ubiquity and Essentiality
To drive its brand, Yahoo! seeks to make it ubiquitous and essential. To make Yahoo! ubiquitous, its services must be comprehensive, open, and available everywhere on a global scale. By comprehensive, Y! means that it can provide many, many services, with more continually becoming available, anywhere to anyone at any time. By open, Y! intends to continue to be the only place to come for all services from its content, commerce, and community value networks, including services that Yahoo and its consumers have not yet dreamed of. Openness requires that Y! be open to all sources of new value, remaining neither proprietary nor exclusive in its partnerships. Availability means that Yahoo! must transcend access and network limitations by extending itself to the maximum reach possible: "the only place for anyone, everywhere," including what the Internet is now and what it will become as it penetrates more space by expanding its openness to new or diverse types of access and networks.
What is essential in you life? Does Yahoo! enable you to find, connect with, and consume what you value? Yahoo! strives to make its portal the only place you need to go to find, to do, to buy: the only place that is essential to living a modern life style, the single trusted place that you go, repeatedly each day, to find friends, lovers, or entertainment, to chat or interact, to schedule or enjoy your social life, to plan your meals, your travels, or your finances, to buy or sell anything, whether at auction, by shopping, or in classified adds or the yellow pages, to make your work or life more informed, more connected, or more interesting, to get directions to drive anywhere or to find a new job anywhere, to discover and educate yourself, to seek or share your expertise, to explore your interests, to play a game, to pay your bills, to aid a charity, or to enrich your life.
Enabling Uses The Principle of Duplication With Feedback
Yahoo empowers personal choice. Yahoo! is a an enabler: it gives you the means, the ability, the power to choose what you find, who you connect with, or what you buy. At its portal, Yahoo duplicates the world of information, commerce, and community, creating the only place you need to enter a virtual world that duplicates the actual world. A virtual duplicate corresponds closely enough to the original in essential dimensions to possess the same force, power, or effect. Although a map is not the territory, the map duplicates certain essential spatial relationships to enable a traveler to move expeditiously through the territory. A duplicate abstracts essential features to meet a particular purpose. In that sense, a virtual world is a model that is designed to be like the actual world in some significant respects. Like all models, you build it, test it, and rebuild it until it works as a virtual duplicate of the actuality that interests you.
Yahoo's essential function is to enable high quality experiences for their users at the only place a customer needs to go to find, buy, or connect. To improve the quality of the experiences of finding, buying, and communicating, Yahoo offers a service, solicits feedback, and improves the service. Yahoo uses information to build the service, more information from its consumers to improve the service, and it does so recursively. This knowledge of how to build, test by securing feedback, and rebuild services is a powerful and valuable intangible asset. It is digital capital. This knowledge-based human capital becomes incorporated into software as structural capital, and the relationships that human knowledge enhanced become customer capital. When you know what works and what doesn't, and how to improve what doesn't until it works, then scaling a business as you simultaneously increase the scope of the services you offer becomes not only possible but also highly likely to succeed. This is how digital capital (or knowledge assets) expands exponentially.
Scale and Scope as Driving Competitive Advantage
How To Scale Globally, Yet Locally. Whereas traditional supply-side scaling, which comes from increased efficiency in production as you move up the learning curve and from scale-induced better prices from suppliers, runs into natural limits from diminishing returns as businesses grow large. However, the virtuous circle in a knowledge company's demand-side scaling is limitless, just as popularity is limitless. As Yahoo becomes more popular with users, the cost of replicating its services in its 24 local presences (and growing) becomes ever cheaper. Its software interfaces must be translated into local languages, but its source code remains standard. To its servers, foreign languages are not Greek, only digital.
Koogle is extending Yahoo's franchise worldwide. Last October, he said, "We'll be relentless in serving our customers extremely well and taking as large a share of the market as possible." Yahoo's strategy is simply to localize the content that appears on their core platform, a platform that was always intended to appeal to a big audience on a worldwide basis. Although the "AOL" and "MSN" names are give-a-ways that reveal them to be American brands, Yahoo's brand name is not strongly identified as American. It is a more universal expression of exuberance.
It is Y!'s business practice to push decisions out to local personnel. "We have a tremendous product advantage in all the services and other media we offer," according to Yahoo's Managing Director of Latin America, Roberto Alonzo, who continued, "our strategy is localize the Yahoo! platform using local people we hire in each country." Localizing content includes much more than translation. Localizing means the News, Sports, Weather, Entertainment, Lottery, Politics, Events, Classifieds, Lodging, Restaurants, Maps, Yellow Pages, Real Estate, Careers, Clubs, Outdoors, Movies, Music, Radio, Auctions, Shopping, Banking, Insurance, Taxes, and much more must reflect that specific locale and its culture. By pushing a global platform down to the local level, a good fit grows even better. As penetration deepens locally, it increases Y!'s essentiality, ensuring that it is the "only place you have to go" worldwide. In newborn and scattered markets, Y!'s product advantages, in breadth and quality, offer compelling competitive advantages. Yahoo! is the place to see and be seen; its popularity reveals the force of strong direct network effects.
If you go online and click Yahoo's "What's New" button and then click "Complete Listing," on any given day you will notice new links to many international sites and some foreign language content. For example, I noticed sites for: Imperial Ethiopia; renting villas in the Portuguese Casa do Sol; buying Fengxi Baita ceramics; Nepal Vision Treks and Expeditions; erotica written in Malay and Indonesian; and some porn sites that I won't try to describe.
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.
How To Have Universal, Yet Personal, Scope. Yahoo! continually grows its range of content, communication, and business and enterprise solutions. The more extensive its offerings become, the more universal they are. This is necessarily so because the universal, which fits the whole of human kind, must encompass each unique individual's interests and needs. As choice expands, everyone is able to find something of value. If you want to find, buy or connect, would you prefer going to one place only or to many? "Many" is too many for most of us. Convenience is a primary desire of consumers.
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.
Like all personalization strategies, MyYahoo! tailors its services to fit the person. Personalization increases both the benefits that he or she receives and his or her switching costs when considering leaving the brand. Once you decide to use Yahoo! Wallet, Paydirect, Bill Pay, Address Book, Calendar, Photos, or Bookmarks, the aggregated switching costs of changing to a new service provider become onerous. Once you and your friends/family decide to use Mail, Messenger, Alert, Photos, and Chat to stay in touch, the problem of coordinating a switch locks you in. A significant difference between Y! and AOL or MSN is that Y! is not a default setting that automatically enlists all novices; the individual who chooses to come to Yahoo! does so because of its branding. If the individual subsequently makes Yahoo! "mine," it is an eternal love. Once tailored to you, the suit fits only you. Once a Yahoo, always a Yahoo.
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. |
