Is Yahoo! Losing its Nerve?

What did Yahoo! CEO Terry Semel and CFO Susan Decker mean when they made comments recently that sounded like the company was throwing in the towel in its long-time rivalry with Google? Should you sell your shares? Not without taking another look at Yahoo!’s strategy.

Some comments made by some high-level executives at search company Yahoo! set keyboards clicking at the desks of industry analysts, bloggers, and interested observers. These comments seemed to imply that Yahoo! had thrown in the towel, and was conceding defeat in the face of Google, its apparently unstoppable competitor. It even sounded as if Yahoo! was actually content with a position in the search market that is secondary to Google’s.

The comments were made in the context of Yahoo! reporting its fourth quarter and year-end financial results for 2005. Susan Decker, the company’s chief financial officer, admitted that “We don’t think it’s reasonable to assume we’re going to gain a lot of share from Google.” She went on to say that “It’s not our goal to be No. 1 in Internet search. We would be very happy to maintain our market share.” It’s not Yahoo!’s goal to be number one? What kind of talk is that, coming from one of the oldest search companies online?

Even more apparently damning, defeatist words came from Yahoo!’s CEO, Terry Semel. In an interview with the Associated Press, Semel said that “Frankly, Google has done a better job than us. It’s like we built our house first and someone came along and built an even better house.”

This kind of talk, coupled with results that fell short of expectations, certainly didn’t help the company’s stock. Yahoo!’s shares fell more than 12 percent after the announcement. What’s a shareholder to think — or do — when it sounds like the fight has gone out of a company? Some would sell. To my knowledge, I don’t own shares of Yahoo!, Google, or any Internet search company, but rather than selling, I would suggest digging deeper. As any journalist will tell you, remarks are at least sometimes taken out of context, and then spun in whatever way suits the story.

{mospagebreak title=A Closer Look at the Results}

So what was it about these financial results that was awful enough to inspire such a drop in the price of Yahoo! stock? Keep in mind as we take a look at these figures that I’m not really a financial analyst; I’m just a layperson who has spent a few years reading company financial results as part of my job. And maybe that’s why I don’t quite see why everyone is so horrified.

Yahoo!’s gross profit increased 34 percent over the year-ago quarter — and net income for the fourth quarter nearly doubled, from $373 million in 2004 to $683 million in 2005. On a per-share basis, that’s $0.46 versus $0.25 a year ago.

Revenue for the quarter was up, too, of course. It reached a total of $1.5 billion, a 39 percent increase from the $1.08 billion earned in the comparable 2004 period. In order to get a better picture of Yahoo!’s revenue, one should subtract the advertising commissions that it paid to other websites. After performing that bit of math, we find out that the company’s fourth-quarter revenue came to $1.07 billion, which was in line with analyst estimates — and still up 36 percent from the same period a year ago.

So if it’s not obvious from the quarterly results what has everyone upset, what about the year-end results? For all of 2005, Yahoo! earned $1.9 billion, or $1.28 per share, on total revenue of $5.26 billion. That’s much better than it did in 2004, when the company’s net income was $839.6 million, or $0.58 per share, on total revenue of $3.57 billion. Most companies, and their stockholders, would be ecstatic to see that kind of growth.

But industry analyst Safa Rashtchy of Piper Jaffray put a finger on the problem. “Yahoo! has a good story going; it’s just not as good as Google’s,” though, as of this writing, Google has not yet released its financial results for the quarter. “We would expect to see faster growth in a growth market that seems to be on fire like this one.” Indeed, another commentator pointed out that this was the second consecutive quarter in which Yahoo!’s earnings growth was interpreted by investors as a sign that the company isn’t leveraging the exploding online advertising market as well as Google. So the analysts are looking for growth — but they just might be looking in the wrong place.

{mospagebreak title=How’s this for Growth?}

Growth comes in many different forms. For example, part of the gain seen in Yahoo!’s 2005 financial results came from a complex deal that left it with a 40 percent stake in If you haven’t heard of this company yet, you will — it is China’s largest e-commerce company. China is the second largest Internet market in the world, right behind the United States, and poised to continue growing. The stake puts Yahoo! in a good position for expansion into this market.

Another form that growth can take shows up in the size of the company itself (though it’s not a wholly reliable indicator, of course; not every company’s headcount growth is a sign of health). Yahoo added another 674 employees during the fourth quarter. Its payroll now stands at 9,816. That headcount is 30 percent higher than a year ago.

When it comes to a service like search, which is supported by advertising, size matters — in this case, the size of the audience. Here again, Yahoo! saw quite respectable growth. The company ended 2005 with 365 million users, a 21 percent increase from 2004. The definition of “user” seems to vary a bit, though; by some accounts, Yahoo! has 429 million unique users, more than 200 million active users and 12.6 million unique paid relationships with users who subscribe to various Yahoo! services, such as online music. Overall traffic across all of Yahoo!’s websites grew nine percent to 103.5 million users. According to research firm Nielsen/NetRatings, Yahoo! is reaching about 68 percent of the Internet’s active users.

The varying definition of “user” hints at another area of growth for Yahoo!. The company has been working to become less dependent on advertising for its revenue by diversifying. It is selling more services, such as high-speed Internet access and matchmaking. And those 12.6 million subscribers are nothing to scoff at; it represents an 11 percent increase over the previous (as opposed to year-ago) quarter. Even when you’re making more than a billion dollars, the $186 million in fees paid during the fourth quarter by all of those subscribers amounts to a nice bit of bread and butter — and that number is set to keep growing. Looking ahead, Semel stated that “This year we are poised to surpass 15 million paying relationships.”

This is very good news, considering that 2006 might be a brutal year for the venerable search company. It expects to lose about $120 million in ad revenue from affiliates, mostly because Microsoft’s MSN plans to move to its own network in June. On the other hand, Semel didn’t sound too worried about this upcoming challenge when he spoke with CNet. “We are the largest Internet network in the world, with the largest number of users and the most-engaged users. We’re seeing growth in all our product categories…Nearly 40 percent of everybody who came onto the Internet last quarter touched Yahoo! somehow. We think we’re in a terrific position.”

This doesn’t seem to jibe with the quote from Semel at the beginning of this article. How can the man who admitted that Google “built an even better house” than Yahoo! be reconciled with the man who thinks Yahoo! is “in a terrific position”? The answer depends on where you set your sights — and how you define success.

{mospagebreak title=Yahoo’s Goal is not Google’s Goal}

If you’re examining Yahoo!’s and Google’s search engines, one point worth keeping in mind is that Yahoo! didn’t even own its own in-house search engine until about two years ago — no, even less than that. Until that time, Yahoo!’s search was powered by other companies — including, at one point, Google. So in that sense, Yahoo! has come a long way in a short period of time — but it seems to me that search is not necessarily Yahoo!’s biggest priority.

Many observers think it should be. Danny Sullivan, editor of, sounded a bit bewildered when he heard about the controversial comments from Yahoo!. “It kind of makes you wonder about how serious they are about search,” he said. He thinks that “It really ought to be their goal” to be the top search engine, “whether it’s realistic or not.” He may well be missing at least part of the point.

Jordan Rohan, an analyst with RBC Capital Markets, sees some of the problem. “In some countries, it’s already game over in search, with Google the clear victor. Google’s product development pipeline runs at such a fast rate that it’s very difficult for any company, Microsoft or Yahoo! to catch up.” It’s not just about search anymore; it’s about the products companies create that help people to use, share, find, and otherwise manipulate data. Even more importantly, it’s about making those products pay, either directly through subscription fees, or indirectly through using the products as a platform for advertising.

Decker made that point in an interview after Yahoo!’s earnings were announced. “Our goal has been to hold our share and to be a leading, if not the leading, total marketing platform, which would include both brand and search.” But Yahoo!’s own company blog makes the case even more plainly. Written shortly after the earlier controversial comments hit the press, the entry for January 24th was titled “Are you kidding?!” and worked to refute the speculation about Yahoo!’s commitment to being the best. It said in part that “We’re continuously innovating and finding new ways to help people connect to information and knowledge — part of our vision to help them find, use, share and expand all human knowledge. We’re working on literally hundreds of projects to improve search…”

Yahoo! has built itself over a decade or so into an Internet portal; it has a lot more experience at this sort of thing than Google. That’s no guarantee that it will get it right in the long haul, of course, but this could still turn into a tortoise-and-hare race. But then, why should Google try to be like Yahoo! — or vice versa? That would be rather like saying that Apple should work to be like other computer makers to claim more market share. There’s room enough, and customers enough, for two very different companies in the same field to find enough customers to stay alive and prosper.

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