Yahoo! Inc. (YHOO) Changes Direction with Tumblr Purchase

The recent announcement that Yahoo! Inc. (NASDAQ:YHOO) will buy Internet blogging startup Tumblr for $1.1 billion in cash has led to immediate criticism from a wide swath of the analyst community.  Most of the commentaries so far have centered on the fact that Yahoo! might have paid too much for a company that has yet to prove itself as a viable revenue generator, though some also relate to general incompatibility between the corporate vision and culture of both entities.

When we look at the possible reasons why Yahoo! Inc. (NASDAQ:YHOO) decided to pull the trigger on the biggest social-network purchase of the last few years, however, a new set of difficulties can be identified. Is the company’s latest attempt to change directions and focus on its social networking deficiencies destined for failure? If history is any indication, there are real reasons for concern.

Yahoo!’s past experience with startups

Yahoo! recently selected a new CEO in Marissa Mayer. The company is hoping she will be able to restore its reputation, especially in dealing with Internet startups. Past failures in this area were seen with GeoCities (one of the web’s earliest social networks), which was acquired for $3.6 billion, and the photo-sharing site Flickr (which came with a $35 million price tag). Both of these startups were underutilized by the company, leaving Yahoo! Inc. (NASDAQ:YHOO) open to the criticism of a similar outcome for Tumblr. One of Mayer’s first major tests in Yahoo!’s lead position will be to find ways of matching Tumblr’s social network with Yahoo!’s goals. The company hopes to re-establish its previous dominance in digital advertising as well as build a larger presence on mobile devices.

Revenue challenges

Yahoo! Inc. (NASDAQ:YHOO)’s aim to reposition itself as a player in social networking means that the company will face the revenue challenges that have become a staple characteristic of the sector. One notable example of these difficulties was seen after Facebook Inc (NASDAQ:FB) acquired Instagram for $1 billion, only to find afterward that the site’s revenue contributions were negligible. Facebook continues to receive pressure from investors to turn user activity into advertising dollars while meeting the needs of a consumer base that is increasingly reliant on mobile devices.

For Facebook Inc (NASDAQ:FB), the worst part is that these trends have not changed in recent months.  A report this year from the Social Media Examiner shows that only 37% of those in marketing positions believe advertising on Facebook Inc (NASDAQ:FB) to be an effective method in selling products. The report found these trends to be especially true when looking at smaller businesses or ones that target older demographics.  The problems at Facebook are very similar to what is seen at Yahoo!, and Facebook’s results should be looked at as a harbinger of things to come at Yahoo!.

Attempts to regain advertising market share

When we look at the recent earnings performance at Tumblr, some similarities become apparent. Tumblr’s reported revenue for 2012 was $13 million. This figure was matched in the first quarter of 2013, but the company’s goal of reaching $100 million by the end of this year look’s questionable. Tumblr ran through $25 million in cash last year, so it will take innovative alternatives to traditional web advertising to reverse these trends and positively contribute to Yahoo! Inc. (NASDAQ:YHOO)’s profit performance.

Yahoo!’s decision to change its focus and devote more resources to social networking comes directly from its goals to regain some of its lost market share in digital advertising. From 2009 to 2012, Yahoo! lost nearly half of its share of advertising revenue. During that same period, Google Inc (NASDAQ:GOOG)’s advertising presence improved massively, and the company now receives more than 40% of all revenue from Internet advertisements.

The competition between these two companies is fierce, but most of the prevailing arguments suggests that Yahoo! Inc. (NASDAQ:YHOO) is the major laggard.  Both are key names in search, but it is Google Inc (NASDAQ:GOOG) that has amassed clear superiority in this area.  Yahoo! has pulled ahead in the daily news area, but with Google’s continued attempts to move forward in mobile devices, Google remains better-positioned in terms of consumer software trends.

Likely Outcomes

Even with a global community of 134 million and roughly 108 million blog pages, it is unlikely that Tumblr’s networks will pose much of a threat to Google+ or Google’s dominant position in the ad space. This leaves the main question moving forward as whether Yahoo! Inc. (NASDAQ:YHOO) will be able to apply Tumblr’s strengths to its key areas of weakness, avoiding another startup failure reminiscent of Flickr or GeoCities.

Yahoo! is a very late arrival to the social networking game, and its purchase of Tumblr represents what could either be a golden opportunity to reassert itself or a call of attention to its consistent inability to successfully manage its startup enterprises. With a purchase price of over $1 billion, Wall Street will be watching Tumbler’s performance much more closely into the end of the year.

Richard 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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