I’m a Yahoo! Inc. (NASDAQ:YHOO) bull. I’ve had a good run since Marissa Mayer took over. But I haven’t yet seen organic growth.
What helps me remain bullish is that she seems to have a vision for the company, one that she seems to be executing.
So let’s talk about that vision, what might cause me to change my view, and why – if you’re looking for tech profits – it remains a solid choice for capital gains.
The Yahoo! story
For over a decade Yahoo! Inc. (NASDAQ:YHOO) did what Wall Street told them. It became a media company. It has major assets in finance, news and sports. It has a radio network.
From her first interview, Mayer set out to change that. She said Yahoo! should be a tech company again. That would mean dramatic increases in the number of highly-skilled developers and entrepreneurs within the company. It would be expensive, but Yahoo! Inc. (NASDAQ:YHOO) was already the birthplace of key cloud technologies like Hadoop, and if led by an engineer techies respected, it could turn around.
The Tumblr acquisition was a key point in this transformation. Mayer shopped carefully for nearly a year before pouncing on this company. What was Yahoo! thinking, our Daniel Sparks asked.
Here’s what they were thinking. Tumblr was a cloud development company, based in New York, with an offer that Madison Avenue and the Rocks (where the networks live) both found compelling. It had a user base that could be monetized, but most important it had a staff that understood how to bring a cloud-based consumer product to market, scaled and ready for the millions.
Yahoo! Inc. (NASDAQ:YHOO) has since furthered what the media calls its “quest for youth” by buying PlayerScale, which helps game makers port their products to a variety of different platforms.
You need to understand here that the “quest for youth” doesn’t just revolve around users. It involves developers. Yahoo! needs a large, cohesive development team that can imagine new cloud applications, build them, and maintain them, at a pace competitive with its key competitors, like Google Inc (NASDAQ:GOOG) and Facebook Inc (NASDAQ:FB). (More on them soon.)
The Yahoo! danger
Yahoo! Inc. (NASDAQ:YHOO) isn’t Google Inc (NASDAQ:GOOG). That’s good. It has a lot of room to grow, which means investors have a lot of room to profit in the form of capital gains, before it hits anything like a ceiling. Since Yahoo! doesn’t yet have as much data center capacity as Google, it also has an advantage in that it can build from scratch, using 2013 pricing and technology, rather than being limited by what Google Inc (NASDAQ:GOOG) built in the last decade.
The danger is that it fails to keep its teams together. Many tech companies buy operating companies and then let the developers walk out the door. Yahoo! Inc. (NASDAQ:YHOO) can’t afford that. It has to keep its Tumblr and PlayerScale people inside the company, not only building out what they have but building additional teams within Yahoo! for other products. Making Yahoo! a competitive cloud development shop is Mayer’s primary mission, that means young developers with cloud skills, and 2013 work habits.
So if you see job hops about Yahoo! Inc. (NASDAQ:YHOO) programmers leaving in droves for start-ups, or see its competitors picking up top Yahoo! developers for new projects, that’s a danger signal. That’s when you need to question your investment in Yahoo! and consider taking your profits out.
Google and Facebook
Let’s also take a look at two possible alternative investments before we go, Google Inc (NASDAQ:GOOG) and Facebook Inc (NASDAQ:FB).
Google has massive advantages over Yahoo! Inc. (NASDAQ:YHOO) in terms of its infrastructure and costs. It is also achieving organic growth from in-house developers who can both create new products and enhance existing ones to keep them competitive.
But like every big company – like Apple Inc. (NASDAQ:AAPL) for instance – Google Inc (NASDAQ:GOOG) is reaching a ceiling. It had $500 million less in revenue during the March quarter than in December. Bulls will say that it’s all seasonal, that the March quarter was 30% better than what was achieved a year earlier. But as numbers get bigger they get harder to grow. Apple Inc. (NASDAQ:AAPL) has found that out. When investors realize that’s true with Google as well, there will be a reckoning, and today’s earnings multiple of 26 will start to look terribly expensive next to Apple Inc. (NASDAQ:AAPL)’s 11. Yahoo! Inc. (NASDAQ:YHOO)’s is technically 7.5, but that’s artificial, the result of its sale of half its Alibaba stake last year.
Facebook offers a more direct comparison with Yahoo! Inc. (NASDAQ:YHOO). The two companies are relatively similar in terms of revenue – Facebook Inc (NASDAQ:FB) is 40% ahead of Yahoo! in terms of quarterly revenues, although Yahoo! was nearly twice as profitable last quarter, earning $390 million against Facebook’s $219 million.
The larger point is that these two companies are similar in the way they run. Both are scaled cloud development shops with their own data centers. Both target similar user bases, and both seek developers and entrepreneurs from the same pool. Facebook has proven it can get organic growth, in terms of new products and features, from its existing staff. That’s the model Mayer is trying to build inside Yahoo! Inc. (NASDAQ:YHOO).
The difference is that while Facebook Inc (NASDAQ:FB) does all its work from within a Silicon Valley corporate campus, Yahoo! is trying to spread its work around, while Mayer fixes what’s wrong at the center. My guess is that Tumblr may be just the first of several “mini-Yahoo! Inc. (NASDAQ:YHOO)s” around the world, built through acquisitions as Mayer seeks to create a network of entrepreneurial cloud development shops in major business centers.
My Foolish take
Right now Facebook has a market cap of about $60 billion. Yahoo! has a market cap of just $29 billion, and much of that is based on its continuing ownership of 20% of Alibaba, which has yet to develop an American arm or become the global power its founder Jack Ma wants it to be.
I see a lot more potential in Yahoo! Inc. (NASDAQ:YHOO) going forward than I do in Facebook Inc (NASDAQ:FB). The company is less than one-tenth Google Inc (NASDAQ:GOOG)’s size, by revenue, and thus has ample room to grow before worrying that top-line gains are difficult.
There is risk here. Mayer is key to Yahoo!’s success. She’s as important to her company as Zuckerberg is to his, even more important than Google CEO Larry Page is to his. She has not yet begun to fight.
The fight is going to be fun to watch.
The article What Can Stop Yahoo!? originally appeared on Fool.com.
Dana is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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