Five Reasons to Sell Your Yahoo Stock

Shares of Yahoo! (YHOO) are falling 5 percent in after-hours trading tonight after the company reported first quarter earnings of 10 cents per share, a penny below analyst estimates. If you are an investor in the company, here are five reasons to sell your stock:

1) They are overhyping Panama

CEO Terry Semel and company have been hyping their new ad platform, Panama, ever since it launched. Yahoo! stock has risen 25% so far in 2007 mostly due to the fact that it appeared the new system would really boost results. With first quarter profits below expectations and second quarter guidance in-line with projections, it appears they are overhyping Panama’s potential and any benefits from it are clearly priced into the shares already.

2) Growth in the U.S. is over

I was amazed when I saw this figure in their press release. Revenue in the United States for the first quarter was $1.1 billion, growth of zero percent over 2006. This should be a red flag. It’s true that international market opportunities trounce those domestically, but Yahoo! stock is selling for prices that reflect a high growth Internet leader. With no growth in the U.S. it will hard for the company to deliver superior results going forward.

3) Their time has passed

There was a time when Yahoo! was hot. Those days are over. Their email is still popular and I pay them 20 bucks a year for their fantasy sports program, StatTracker, but Google is eating their lunch in search and other properties Yahoo! bought a long time ago to diversify out of search (HotJobs, etc) just are not going to be growth engines. They just can’t stand out from the crowd anymore.

4) Google is eating their lunch

When Google reports first quarter numbers on Thursday, you won’t see U.S. growth anywhere near zero. Google has taken over Yahoo!’s leadership position in search and internet advertising and has the cash stockpile to continue to innovate and grow faster than Yahoo! can. There is certainly room for more than one player in this market, but without major changes at Yahoo! it is hard to see how they will reinvent themselves.

5) Google shares are cheaper

This is best reason of all to sell the stock. Google has the momentum, more growth, more resources, and amazingly, a cheaper stock! Google shares trade at a 2007 p/E of 33, versus 59 for Yahoo. Why not just sell your Yahoo! shares and buy Google? There is more growth potential and even if you believe the potential to be a little overhyped, you are paying a lower multiple of earnings to get a faster growing business anyway.

Full disclosure: Long Google and short Yahoo! at time of writing

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2 Thoughts on “Five Reasons to Sell Your Yahoo Stock

  1. David on April 18, 2007 at 7:59 AM said:

    I’m gonna be honest – I love your blog. But I think there are some misleading statements in this post. Mind you, I don’t really invest in companies with ratios the size of Yahoo or Google so this has no effect on me, but…

    1. How is the fact that Yahoo said it maintains its previous projections an indication that Semel overhyped Panama? Doesn’t it just mean that the company was spot on in its projections and was actually being realistic instead of telling Wall Street analysts the optimistic sweet nothings that they love to hear?

    2. Growth in the US is not over. It was adversely affected by two major items: First, Yahoo anniversaried its contract with Microsoft, which was still in effect in last year’s Q1 and has now been taken in-house by Microsoft. This is a one-time event. Second, Yahoo has purposely cut its revenues this quarters in order to transition to Panama and upgrade the quality of its advertising space – this should grow revenues and profits in the long run, but the company made an intelligent long term decision to cut its revenues and profit in the short run. Even including these two factors, Raw revenues still increased, and it was revenues ex-TAC that remained stagnant. TAC fees as a percentage of raw revenues will not drop forever.

    3) I wouldn’t so quickly state that their time has passed. This is a business with no switching costs and over the long run, it is certainly possible for them to beat Google. They probably won’t, but that’s not what makes or breaks the investment case. The fundamentals of the business are still quite strong and in terms of valuation…

    4) you are misvaluing Yahoo vs. Google. Yahoo’s actual PE is overstated pretty much everywhere. Their investments in affiliates, whose income is not included in Yahoo’s operating income, are valued at MARKET VALUES of $8.6B. Add in the $2.5B of net cash on the balance sheet, and their non-operating assets are valued at around $11B. Their market cap, after today’s debacle, is $38.5B. Subtract the non-operating assets, and their enterprise value is $27.5B. Their EBITDA last year was $2B, bringing their EV/EBITDA multiple to ~13.75. Assuming that their maintenance capex is very small (which is obviously true for any internet company), their EV to operating income is probably somewhere ~14-14.5. Most newspaper companies out there trade in the EV/EBITDA range of 11 and EV/EBIT range of 12-13. Google, to use your example, trades at an EV/EBITDA of 29.5 (using 2006 numbers – I think it’s insane to use FY 2007 estimated numbers for both Google and Yahoo, b/c analysts have no clue what they’re projecting, especially with Google, which makes absolutely no forecasts – if only Yahoo would learn from its larger peer). Now, I know Google deserves a higher multiple than Yahoo. But more than double? While I don’t think that it’s totally non-feasable (it is certainly possible that Google’s growth rate justifies this multiple), I wouldn’t put on a trade to bet on it. Granted, I wouldn’t bet against it either. But it’s ceratinly not obvious and not a home run investment to bet that Google trades at a larger discount to its intrinsic value than Yahoo.

    Just wanted to say again, that I love your blog and think your work on RSH in particular, and investing in general is superb. I just disagree here.

  2. Chad Brand on April 18, 2007 at 9:20 AM said:

    Hi David,

    Glad you enjoy the blog. It certainly doesn’t bother me in the least that you disagree here. It’s just my opinion and only time will tell if it is right or not. Nobody is always right in this game, we just hope to maintain a solid batting average.

    Let me address the points you raised (and thank you for them by the way) as I don’t think anything was really misleading, even if it is arguable.

    *Semel overhyping Panama

    If management comes out and says that Panama is doing great, then the numbers should back this up. Analyst estimates were not bumped up based on his comments, because he wasn’t specific as to numbers, but the stock ran up dramatically in anticipation of increased guidance. Then we hear that Q1 was light.

    Now, investors should not have expected much strength from Panama in Q1 due to its release date, so that’s not a big deal. But, Q2 guidance was in-line and cautious. Now, YHOO hadn’t given guidance for Q2 yet when Semel made those comments, so they did not just reiterate their prior Q2 guidance this week. Semel knew where the numbers were for Q2, made bullish comments that led investors to believe numbers would be above expectations, and then Q2 guidance was given in-line with expectations.

    I stand by my opinion that they were overhyping Panama’s effect. If you make a point to come out and say how good things are, and then your financial projections don’t reflect that, I think it’s a poor job on management’s part. The result was the stock priced in increased guidance, it didn’t come, and the stock sold off dramatically.

    *Growth in the U.S. is over

    I’m not saying the U.S. business will never grow again, but the fact that it was flat this quarter tells you that they don’t have much in the way of growth engines. If they did, they could make up the lost MSFT business.

    I don’t agree that they purposely cut back revenues this quarter. Surely some advertisers held back until Panama was up and running and they could see how it looked, but I doubt YHOO actually turned away business that was thrown at them.

    Raw revenues don’t really matter. Ex-TAC is what they get to keep, so that is the relevant number to use, in my view. Even if U.S. revenue growth resumes, how much will it grow by and will that be enough to justify the stock’s valuation? This is again a matter of opinion. I am not overly impressed.

    *Valuation

    The argument here is always that YHOO’s equity interest in YHOO Japan and Alibaba are not reflected in the stock’s market cap. This is true, but they do include profit from those interests in their income statement. According to YHOO’s 2006 annual report, income from equity interests for the year was $112M, which is included in their $751M net income figure for the year. I think it is unfair to add in the value of the stock and include income from those businesses. It’s either one or the other. And since I prefer to look at earnings, the income generated from those investments is factored into the stock’s multiples. Unless they sell their stake, it’s market value is less important than how much money it is actually earning them.

    I don’t agree with your $2B EBITDA number for YHOO in 2006. Their annual report shows 2006 net of $751M and EBITDA of $1,334M. It is true that GOOG is more expensive if you use an EV/EBITDA measure, but it is not double as you suggest. Using 2006 numbers it’s more like 38x versus 27x.

    Given that Google is spending money like crazy and YHOO isn’t, combined with the fact that you really should use 2007 numbers (Wall Street is forward looking and GOOG will dramatically outgrow YHOO in 2007), that gap is really far smaller. If things keep going as they are, GOOG won’t be more expensive than YHOO on that measure either for very long.

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