Yahoo Stock Analysis
December 1998
Yahoo, the most recognized name online (other than good old America Online). But does that name justify a market cap of $25 billion? In the near term, we have to say that supply and demand justifies at least a $25 billion market cap for the largest pure Internet play, therefore making this a potentially large short term winner.
For the long term we need to look for fundamentals. As we explore these fundamentals that a stock must eventually be valued on, we will come to conclude that Yahoo is an excellent long term hold, that will represent a compelling value on any pullback from recent levels.
The highlights of the Yahoo! investment thesis include:
Internet use will double in the next 24 months, providing extraordinary underlying market growth.
Yahoo's #2 market position, only trailing America Online, provides them unparalleled bargaining power.
With an impressive 25 million users, and 144 million daily page views Yahoo has emerged as a clear Internet leader.
Viral marketing continues to drive growth, primarily through the Yahoo Mail and merchant agreements.
Gross margins for Yahoo could reach an impressive 90% as the business model flourishes.
25%-30% quarter over quarter growth is unattainable in any other industry.
200%+ revenue growth is still readily attainable even 4 years into the company's life.
Continual upside surprises (because of reluctant analysis) should continue to drive short term performance.
Yahoo's Model
Yahoo has a simple objective in the words of Tim Koogle, CEO and President. Yahoo simply must be "the only place the 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."
Based on this goal, Yahoo has developed a three tiered strategy: content, community, and merchandising. Instead of attempting to develop their own content, as the Microsoft Network, and Go.com have attempted to do, Yahoo! has instead chosen to aggregate established content. Yahoo's news and content sources include respected names such as Reuters, Ziff-Davis, The Motley Fool, CBS, and others. The Yahoo community has been built around its extremely popular message boards, a text based messaging system, and its new community forums run by Yahoo users. Yahoo's merchandising activities are its newest expedition. The Yahoo business model has worked well in this area, with Yahoo Auctions proving an early success, Yahoo's merchant area hosting nearly 3000 online businesses, and partnerships proving successful with Amazon.com, CDNow, AT&T, and Ticketmaster.
The Revenue River
Yahoo derives revenues from two primary sources: advertising and commerce. Advertising continues to be the largest source of revenues for Yahoo. In the third quarter, advertising revenue rose 29% compared to the second quarter to $39 million. Revenue per advertiser climbed over 17% to $27,000, showing that online advertising continues to grow in importance as a medium. The amount that Yahoo receives per thousand ad views (CPM) has remained steady around $25, a number that most Wall Street analysts expected to decline. Meanwhile the inventory sold increased slightly in the third quarter. Yahoo now hosts advertising for over 2,000 companies, with a retention rate of 90%. Most impressively, over 40% of Fortune 100 companies are either advertisers or merchants on Yahoo.
Commerce revenues are quickly growing in their importance to the Yahoo model. Last quarter, they grew 32% to $14 million, representing 26% of revenues. The majority of this revenue is still based on impressions generated for premier merchants, however the presence of transaction based revenue is increasing rapidly. The boom in e-commerce should be a key growth factor over the next 36-60 months.
Parabolic Growth?
Perhaps the most impressive part of the Yahoo story is its seemingly unending growth curve. From nearly identical beginnings, Yahoo has outrun all other portals. The Yahoo network of sites now serves more daily page views than Excite, Lycos and Infoseek combined. That lead should extend, as Excite was the only portal in the last quarter to exhibit Yahoo like growth.
When Yahoo reports 4th quarter results they should surpass an impressive 30 million registered users. Daily page views should jump to 190 million, from 144 million in the third quarter. Revenue growth quarter over quarter could surpass 30%. Bottom line (earnings) growth will be an astounding 700% year over year.
Those type of metrics are why people are excited about the Yahoo story. In a world economy with declining profits, and decelerating growth, Yahoo offers momentum like no other.
The Vital Metric: Margins
Perhaps the most exciting part of the revenue growth story at Yahoo is the margins the company is realizing. While only selling 20% of available ad impressions, Yahoo's gross margin has climbed over 90%. Few other businesses will ever find a model that produces 90 cents of gross profit on the dollar. As web advertising becomes the most important medium of the 21st century, Yahoo's gross margin could conceivably climb another 300 basis points (3%).
Further growth, and realized economies of scale, will also drive operating margin far beyond its current 32%. As product development, and sales and marketing expenses continue to dwindle as a percentage of revenues, operating margin could climb beyond 50%. That type of margin growth, combined with 200%+ revenue growth would lead to over 350% earnings growth.
Where to from here?
We anticipate that Yahoo will continue to launch countless new properties in an attempt to extend its business model into promising new areas. With the past success of new Yahoo ventures, we have no doubt that this will prove fruitful.
There is no doubt that the Yahoo model is powerful, that future earnings and growth will be unprecedented, and that the Yahoo business model has a lot of upside. The question though, lies in future valuation metrics. For our pinpoint of Yahoo's future price, and present fair value, take a look at our valuation model. You will notice that our estimates are generous, from both an earnings and a multiple standpoint.
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