An Old Dog with New Tricks

06/24/2010 10:53 am EST


Michael Brush

Columnist, MSN Money

Michael Brush, contributor to MSN Money, sees potential in the transition under way at Yahoo.

Back in the day, Yahoo (Nasdaq: YHOO) created popular sites such as Yahoo Finance and Yahoo Sports to bring in tons of traffic, then sold lots of display ads to mint money. Applying this formula, Yahoo produced phenomenal sales growth, averaging 55% a year from 2001 to 2006, keeping the company going despite deep stock losses when the Internet bubble burst.

Then a new form of Internet advertising hit its stride: paid search, payment for the placement of ads next to search results at sites such as Google and MSN. Yahoo's failure to keep up hit the company hard, Morningstar analyst Larry Witt says. Sales growth slowed to 3% in 2008, and sales actually fell last year. Traffic growth has also slowed, as social Web sites like Facebook and Twitter siphoned off surfers.

The stock traded at $15 a share recently, more than 80% down from bubble highs near $108 and from the $40 range at the middle of the decade.

But Yahoo is changing course again these days. Rather than going it alone on search, it's partnering with Microsoft (Nasdaq: MSFT). "It took Yahoo a long time to realize that it is not a search company," says Ryan Jacob of the Jacob Internet Fund (JAMFX), whose fund has bested competitors and the markets over the past five years. "This puts their focus where it should be, on aggregating content, and not competing with Google and Microsoft on search."

Yahoo is also now working with Facebook and Twitter as it tries to retain or boost traffic.

Yahoo is building up its original content stores, most recently by purchasing Associated Content, a Web site that publishes work by freelance writers. And it's modernizing its technology platforms so it can more easily move content around and match it with advertisers.

"The idea is to develop platforms in the cloud where we can quickly retrieve content and put it anywhere on any property in the world," Yahoo chief Carol Bartz said in the company's most recent conference call with investors.

This [transition is] a work in progress. It has many doubters, which is why the stock is so cheap. But Yahoo has a strong financial position that gives it room to execute. Besides more than $4 billion in cash, Yahoo has a 35% stake in Yahoo Japan and a 40% stake in Chinese Internet company (OTC: ALBCF), which investor George Soros also owns a big stake in. At the end of March, those two positions were worth $10.4 billion to Yahoo, more than $7 a share.

Citigroup analyst Mark Mahaney believes Yahoo's projected sales and profit margin gains will produce 24% to 40% in annual earnings growth over the next three years. He has a buy rating on the stock and a $22-a-share price target. He suggests buying shares under $16.

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