Behind the Yahoo [a must read]
BUSINESS WEEK ONLINE
July 9, 1998
STREET WISE by Sam Jaffe
BEHIND THE YAHOO! HOOPLA IS A SOLID STOCK
It's easy to ridicule the high stock price of Yahoo! (YHOO). The Internet portal service -- so-called because so many people use the Yahoo! search engine to get onto the Net -- is worth 16 times what it was when it went public in April, 1996. If you applied Yahoo!'s price-to-sales ratio to Coca-Cola (KO), you would end up with a share price for the soft-drink maker above $700, vs. the current $87 and change. As of Yahoo!'s close on July 8, you could pay $186.19 for a stock that produced profits of only 15 cents per share and revenue of a modest 75 cents per share in the second quarter. Who in their right mind would pay so much for such modest results?
It isn't who is doing it that matters, because somebody is. The real question is: Are they in their right minds? And the answer -- surprisingly -- is that they aren't exactly crazy.
That's because Yahoo!, while overpriced at the moment, does have a solid business model and is one of the only Internet companies that's making a profit of any size. If it can generate earnings now, at the birth of the electronic commerce age, then its prospects 5 to 10 years ahead could be impressive (or so the thinking goes). The main advice many investment experts issue is to wait to buy until the stock takes a dip of 10% or more.
To understand how Yahoo! makes money, and will make it in the future, you have to swallow a fundamental fact that's distasteful to any rational investor: Yahoo! doesn't make anything. It is, more than anything else, a brand name, like Tide or Clorox -- minus the detergent. "Yahoo! is not an information provider," says Prudential Securities analyst Paul Merenbloom. "It is an information broker. You might see 10 different Broadway shows, but chances are you used one ticket broker for each purchase. Yahoo! is the broker that joins the viewers to the sellers."
Currently, the sellers are advertisers who pay to place their ads on Yahoo!'s site. That's where nearly all of the company's $42 million in second-quarter revenue came from. In the future, if Yahoo!'s strategy works, its revenue base will broaden to include E-commerce done through sites that it prominently features. For instance, software retailer Egghead.com (EGGS) advertises heavily on Yahoo!. According to the terms of its deal, Egghead will pay a certain percentage of total revenue (a figure that hasn't been disclosed) to Yahoo! in exchange for prominent placement of Egghead ads. Right now, Yahoo! isn't getting any of that money, since Egghead hasn't reached the (again undisclosed) minimum revenue figure that it has to pass before Yahoo! gets its share of the sales pie.
Arrangements such as Egghead's raise the question of why any retailer would be willing to pay Yahoo! for exposure. That's where Yahoo!'s most attractive trait comes in: It can deliver "eyeballs." With 30 million visits, it was ranked as the single most visited Internet site in June by Relevant Knowledge, a Web-site rating service. Yahoo!'s own estimate is that it averaged 115 million page views a day in June. It has also disclosed that it has 18 million registered users, another sign of the Yahoo! brand's strength. "Branding is more important on the Internet than anywhere else," says Merenbloom. "You can change your phone company, but it's a lot of hassle to do so. To change your portal, all you need is a few keystrokes. That's why the only thing that separates one portal from another is the brand name. And Yahoo! has a brand name."
So does that justify a share price of nearly $200? Certainly not. But to understand why Yahoo!'s price is so inflated, you have to look at its history. It was founded by two Stanford University graduate students, Jerry Yang and David Filo, in 1994. It went public in April, 1996, at an offering price of $13. By the end of last year, it had reached $69, and since then then it has tripled. The mania began in February, when technology investors started to unload large-cap tech stocks, such as Intel and Motorola, that had been hurt by Asia's economic crisis. Internet stocks such as Yahoo! were one of the only technology plays that had no real Asian exposure, so institutions began to pour money into it. By April, it was at $100.
Then in May and June, the heavies weighed in. AT&T tried to buy America Online, but it was repelled and had to settle for TCI instead. Disney paid as much as $235 million for a 43% share of Yahoo! competitor Infoseek (SEEK). NBC, owned by General Electric Co., paid $26 million for a 5% share of CNET (CNWK), which owns a much smaller player in the portal market called Snap!. "The Disney and NBC deals were an acknowledgement that the big media companies haven't figured out this Internet thing yet and are willing to pay large sums for a portal," says Andrea Williams, an analyst with Volpe Brown Whelan in San Francisco. In addition to making portal sites' valuations legitimate, "It's also an acknowledgement that it has become incredibly expensive to build consistent traffic to your Web site," says Williams, "and that the barriers to entry aren't as low as they had appeared to be."
In other words, Yahoo! is worth a high valuation because it was in the right place (the Internet) at the right time (the dawning of the Internet age). More people start their Internet wanderings on Yahoo! than on any other portal, and the future portends that more people will show up, with the potential to buy more things. Who can put a reasonable valuation on a future as bright as that?
The answer, of course, is that nobody can. That's why the stock price has reached the stratosphere. That's also why buying the stock now, even if you believe in the rosiest predictions for its future, is not necessarily the thing to do. Part of the reason is that most analysts agree that the stock is currently artificially high because of the mechanics of the market. Hordes of investors, both institutional and individual, want to buy the stock, but only a limited number of shares are available (less than 8 million are traded openly on the market). So the stock is both in short supply and volatile.
Because of the tight supply situation, BancAmerica Robertson Stephens analyst Keith Benjamin urges patience before you load up on Yahoo!: "Wait for the correction that has to come," he says. Benjamin doesn't agree with some pessimists that the correction, when it arrives, will knock Yahoo! back to a $50 stock. He advises: "If 10% or 20% of the stock has been lost, then you've seen a correction, and it's a buying opportunity, if you're willing to take the risk."
Even so, Benjamin cautions to hold the stock for the long run. Trying to time a stock that for now moves so irrationally is an exercise in futility, he believes. "In the long run, this stock is worth a lot more than $200," he adds. The question is: Just how long is the long run?
Sam Jaffe writes about the markets for Business Week Online
|
