Everything Old Is New Again at Yahoo

 Yahoo's  strategy has evolved over the past 15 years as the company has grown, the industry has evolved, and competitors have emerged. Most recently, the company has been partnering with third parties to provide compelling content and services in an attempt to retain its audience. This strategy of linking to third-party content isn't new, as it was the company's approach 15 years ago. Ironically, the company's intrinsic value is also partially dependent on investments in third-party entities.

Similar to most Internet companies in the mid-1990s, Yahoo's direction was shaped more by the interests of the founders than by a cohesive corporate strategy. In its early years (mid-1990s), the company was simply indexing the Web and providing a directory with links to third-party content. The company eventually started to populate the homepage with ads to monetize the website. However, the company believed that sending its traffic elsewhere was not in its best interest. As a result, one of Yahoo's first significant strategic decisions was to host a wide variety of content (both internally generated and third-party) and services on its own site to increase the advertising inventory it could sell. This strategy also required a significant increase in operating costs, which exploded in growth alongside revenue from 1995 through 2000.

After a brief downturn in 2001 during the bursting of the technology bubble, Yahoo's revenue growth soared again from 2002 through 2006, thanks to acquisitions, new offerings, and secular tailwinds in online advertising. While the recent recession affected the company's growth rate the past two years, the company's revenue had started to fall prior to the economic downturn. The primary headwind was the emergence of  Google (GOOG) and its paid search platform, which was very attractive to advertisers due to its measurability and effectiveness. The popularity of Google's search engine also enabled smaller websites to be found more easily, weakening the consumer appeal of a Web portal like Yahoo. Additionally, it is very difficult for Yahoo to build best-in-class services across all verticals, as other companies have built superior offerings. Examples include ESPN for sports, WebMD for health, CNN for news, Google for search, and Facebook for social networking.

Yahoo's strategy has shifted once again, as the company has started to integrate applications from popular third-party providers (Facebook,  eBay (EBAY), Wall Street Journal, Zynga, etc.) in an attempt to maintain a relevant and popular homepage. While this may backfire by diverting traffic away from its own content sites, we think this strategy makes sense, as a highly trafficked homepage is crucial for Yahoo. The company earns premium rates for homepage ads, and the homepage drives more than half of Yahoo's search queries (and search is the most profitable form of online advertising). In addition to third-party content sites, Yahoo has also partnered with service providers to improve its offerings and save money at the same time. Examples include  Microsoft (MSFT) for search,  Nokia (NOK) for maps, and PriceGrabber for shopping.

Including the applications and various partnerships, the value of Yahoo's site is partially determined by the sites that it links to, just as it was 15 years ago. Ironically, the intrinsic value of Yahoo is also partially determined by outside business lines, including its stakes in YahooJapan and Alibaba. In fact, we think Yahoo's core business is only worth about $6 per share (40% of total value), while its Asian-based assets and cash on hand represent the remaining $9 of our fair value estimate.