In the last few years, Yahoo! Inc. (NASDAQ:YHOO)‘s earnings have been increasingly coming from its foreign investments mainly from Yahoo! Inc. (NASDAQ:YHOO) Japan and its crown jewel, Alibaba. Both these companies have an ever increasing contribution towards Yahoo’s bottom line, in the wake of a weakened position in Yahoo’s search and display businesses.
Luckily for Yahoo, Alibaba Group is worth a lot more than the recorded value on its books. As a result, Yahoo’s intrinsic value is higher than its current market cap. In spite of such good assets in its balance sheet, Yahoo! Inc. (NASDAQ:YHOO) has a number of notable challenges on its sleeves, to turn around the fortunes of its main business.
Yahoo’s Three Major Concerns:
1. Growth in Core Business
Yahoo! Inc. (NASDAQ:YHOO)’s core display advertising business in recent years has not grown at all in the last 3 years. Yahoo is seen as more of display advertising company with a handful of platforms like Yahoo News, Finance, Shopping etc. which have a large and regular base of users. But in recent years, the company’s core display businesses have been losing ground. As a result, the company has been losing out on advertising dollars to other rapidly growing companies like Facebook Inc (NASDAQ:FB).
Unless a major turnaround in its core-business takes place, Yahoo’s net income won’t see much movement. The recent run-up of the Yahoo stock has been only due to the huge gain from the Alibaba sale, which was used to repurchase shares. In fact, Yahoo has been repurchasing substantial amounts of shares in recent years, and going into 2013, another $1.5 Billion can be expected.
2. Search Market Share on the Wane; Revenue Guarantee from Microsoft To End
The highly competitive search engine space is a very enticing and attractive one. But Yahoo’s prominence in recent years in the search engine landscape continues to accelerate. Major beneficiaries have been the king of search, Google Inc (NASDAQ:GOOG) and also Yahoo’s partner in search, Microsoft Corporation (NASDAQ:MSFT). Google has been dominating the global search market for a long time and held more than 65% through 2012. And in the U.S, Google held more than 67% in February 2013, according to industry tracker, comScore.
Yahoo! Inc. (NASDAQ:YHOO) has a search agreement with Microsoft under which Bing provides the query results on search for Yahoo’s platform. As a result, Yahoo keeps 88% of the revenues generated.
But this search agreement with Microsoft has been under-performing, and Microsoft agreed to guarantee a sizable portion of Yahoo’s search revenues in the U.S. and in Canada. But this agreement in will end in March 2013, and Microsoft is no longer required to guarantee revenues to Yahoo.
This might impact Yahoo’s already dwindling revenues even more, with search revenues almost certain to take a sizable hit. Yahoo continues to lose market share in the search engine marketplace, and held only 11.6% in February, down from 12.1% a month ago in the U.S. Microsoft in its own organic search keeps doing well in the U.S. with 16.7% market share.
Yahoo’s revenues from the search advertising business went down from a $3.75 Billion in 2008 to $1.89 Billion in 2012. This number alone paints a sorry picture of the company’s state, and with Microsoft’s revenue guarantee agreement coming to an end, things might get worse for Yahoo’s fortunes in the search engine space.
3. Lower Earnings from Equity Investments
Yahoo! Inc. (NASDAQ:YHOO)’s bottom line years in recent years have been increasingly driven by earnings and dividends from its equity holdings, mainly from Alibaba and Yahoo Japan. Yahoo recently sold a sizable portion of its stake in Alibaba for a cool $7.1 Billion but still retains 24% of the Chinese e-Commerce giant.
However, Alibaba can buyback from Yahoo another ~8% or 261.5 million shares before the highly anticipated IPO of Alibaba. The rising e-Commerce company’s management buying back a huge amount of stock before an IPO at a reasonably high valuation by taking on debt portrays only one thing; the management of Alibaba believes the intrinsic value of the business is much greater.
With another potential and highly likely buyback from Alibaba before an IPO on the cards, Yahoo’s bottom line might get hurt even more, but its balance sheet will love it. Yahoo should try and hold onto its stakes for as long as possible, as Alibaba is already one of the strongest technology companies in the world and will gain more prominence down the road. A reduced stake in Alibaba translates into a noticeably smaller net income for Yahoo.
The Takeaway
Yahoo! Inc. (NASDAQ:YHOO)’s top line revenues haven’t grown in the last 5 years, in fact, they have gone down from $7.2 Billion in 2008 to roughly $ 5.0 Billion. The major positives in recent years have been the increased valuation of its lucrative stakes in Alibaba and Yahoo Japan.
The new management team has taken a few steps like building out a newer homepage, and changes to its email platform, but those alone, might not be enough to engineer a turnaround for the company’s core businesses in the long run. For starters, Yahoo! Inc. (NASDAQ:YHOO) should form an amicable relationship with Alibaba and hold on to its crown-jewel and also be best friends with Microsoft.
The article Three Major Concerns for This Company originally appeared on Fool.com and is written by Ishfaque Faruk.
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