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Can Yahoo!'s Chinese cash buy back innovative credibility?

Stuart Lauchlan Profile picture for user slauchlan October 21, 2014
Summary:
Yahoo!'s profits are bumped up by cash from the Alibaba stock sell off, but as investors circle her, can CEO Marissa Mayer buy her way back to innovation?

We’ve achieved much more than many people realise.

Typically my reaction when tech vendors wheel out the 'best kept secret in the industry' nonsense is a chilly 'well, whose fault's that then?'.

Screen Shot 2014-10-22 at 10.56.35
Mayer - running out of time?

And I'm afraid I'm not much more sympathetic when I hear defensive comments like the above, this time delivered by Yahoo! CEO Marissa Mayer when grilled on what to the outside world looks suspiciously like a not very fast-moving turnaround for her charge.

Mayer, who's been in near-permanent defensive mode since taking the top chair at the beleagured search firm, has been on a minor high this week after the firm turned in profits of $6.8 billion for the three months to September.

That's good, huh? That turnaround plan is finally kicking in, no? Well, maybe. Up to a point perhaps, but it's a very small point.

The harsh reality is that this hefty bump in profits is down to Yahoo!'s disposal of its stake in Chinese e-commerce giant Alibaba, which netted it a cool $6.3 billion.

Closer inspection of Yahoo!'s numbers don't leave much more room for encouragement than those of recent quarters.

Overall, revenue was up 1% year-on-year, a fragile boost undermined immediately by the face that revenue from advertising dropped 5% for the same period.

There are positive notes to be struck. The number of monthly active users on Yahoo! and Tumblr is up 6% year-on-year and now exceeds one billion users.

But essentially it's a depressing story of one step forward in one area, one step back in another.

For example, click growth in the Americas grew 9% year-over-year, but declined in Asia Pacific region, resulting in overall stagnant click numbers year-on-year.

Meanwhile the number of display ads sold is up 24% year-over-year, but the price per ad has declined to 24% year-over-year.

And so it goes on.

Suck it and see

Mayer remains defiant, seemingly arguing that it's better to try out lots of things and see what happens:

If we were to have one positive and one negative, in my view its always better to have more things to sell and then subsequently focus on building greater demand, value and an improved pricing strategy.

While our display revenue has been flat to down, the components of our display have not been. Traditional PC advertising is a sector of advertising and is in decline across the industry. That decline has been steep here at Yahoo! with legacy PC display advertising creating a drag on the business of $60 million or more per quarter.

However on the flip side, our native advertising offer through our Gemini platform has becoming credible strong. This product didn’t even exist six quarters ago. In Q3 native ads had revenues across mobile and desktop of more than $65 million.

The Yahoo! boss still sees sweet spots of growth:

Our investment businesses of social, mobile, native and video are collectively growing 80% year-over-year, and we are gaining momentum in the four key areas of our strategy, search, communications, digital magazines and video.

Mobile in particular remains a top priority. Mayer says mobile revenues for the quatyer were in excess of $200 million on a GAAP basis and predicts gross revenues in mobile will exceed $1.2 billion in revenue this year.

Fundamentally, we are moving from a company that makes web pages and monetizes them through banner ads to a company that makes mobile apps and monetizes them through native ads.

We have effected this transformation remarkably quickly with 44% of our display ads now being native and our mobile revenue now being material. As we continue to think about growth, we know that we’ll say strong here.

Mobile remains the minority of our traffic. And as our mobile traffic grows, we anticipate so will the associated revenue given the effectiveness of our mobile native ads.

As for the controversial Tumblr acquisition of 15 months ago, Mayer says that's paying off:

Their audience grew 40% from 300 million to more than 420 million users. The number of register blogs nearly doubled from 105 million to 206 million, mobile monthly users of their mobile app grew by 50% and perhaps most impressively Tumblr time spend grew from 22 minutes to 28 minutes per Tumblr’s and Tumblr dashboard sessions.

The engagement numbers on Tumblr continue to be really impressive. This year Tumblr has also focus on revenue growth. Today more than 260 of the world’s top brands not only have a presence on Tumblr but also advertising spend on the platform, and that number grows everyday.

Buying our way out of trouble

money-down-the-drain
Perhaps buoyed by this, Mayer openly posits that further acquisitions for growth are inevitable:

The Internet sector is incredibly competitive and inquisitive industry to build products that compete and successfully attract users and accelerating engagement revenue. Acquisitions have not been a choice for Yahoo! in my view, but rather a necessity.

Because Yahoo! is legacy technology, it’s quite aged. It’s important for us to look for opportunities to bring more modern, more cost effective, more efficient and more updatable technology into the mix. We will continue look at building block acquisitions that modernize our technology and our alignment with one of our four strategic areas.

Strategic acquisition should not only build on the four core pillars of our business, search, communications, digital magazines and video, but also go much deeper in our areas of investment, mobile, social, native and video.

But while expansion through acquisition is a perfectly legitimate option, this might also be interpreted as splashing the cash to buy the company some time rather than being genuinely innovative.

My take

Mayer's running out of time and she knows it. 

Activist investor Starboard Value LP is already circling her regime and wants a halt to the acquisitions and an axe taken to Yahoo's "bloated" structure.

It was notable that while Mayer did not dignify Starboard's comments with a namecheck on a conference call with analysts, she went out of her way to highlight how many people her management team have shown the door to since coming on board:

To date we have had nearly 2,000 performance related departures in the company during my tenure.

Hmm, well good for you, but that's a defensive remark delivered off the back foot and it's a limp riposte to what is a savage drubbing by Starboard.

In an open letter to Mayer, the investment firm says:

The $1.3 billion spent on acquisitions has clearly not delivered value to shareholders.  Not only do we believe that many of the acquired companies were, and still are, losing a considerable amount of money, but we also believe that these acquisitions, on a combined basis, have failed to deliver material revenue growth.  In fact, we believe that a number of the acquired start-ups have actually been shut down after being acquired by Yahoo.

Yahoo’s recent strategy of focusing on acquisitions has not worked.  Yahoo’s stock price has merely been buoyed by the strong growth in value of Alibaba.  We understand that the likely result of monetizing Yahoo’s non-core minority investments in the most tax efficient manner likely means that the Company will not have access to those proceeds to be used towards acquisitions. 

To be clear, while Yahoo is trading at such a deep discount to the sum-of-its-parts, we do not believe the Company should be pursuing acquisitions of companies at high multiples of revenue as it has done repeatedly in the past.

The investment giant puts another option on the table: open negotiations to merge with AOL at once:

Based on our analysis, we believe that a combination of Yahoo and AOL could offer synergies of up to $1 billion by significantly reducing the cost overlaps in their Display advertising businesses as well as synergies in corporate overhead.  Importantly, we believe the combined entity would be able to more successfully navigate the ongoing industry changes, such as the growth of programmatic advertising and migration to mobile.  In addition, we believe a combination could also lead to revenue growth opportunities given the broader user base, higher quality content, better technology assets, and enhanced relationships with advertising agencies.

Whether that comes to pass is a highly moot point. Mayer will only promise, in a short prepared statement, to “review” the Starboard letter.

Meanwhile it's acquisitive business as usual. According to Techcrunch, the next deal on the table is a $700 million buyout of video ad tech firm BrightRoll. This might bolster Yahoo!'s tech in this space and add to its user footprint, but it does nothing to solve the real problem: convincing the advertising world that this one time web pioneer has a credible future in the face of competition from Google and Facebook.

Mayer reminds us that she and her team came to Yahoo in order to:

return an iconic company to greatness.

It's a laudable ambition. Just not seeing it happen.

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