Yahoo Still in Midst of Turnaround
Investors should wait for a wider margin of safety before buying Yahoo shares, says Morningstar’s Rick Summer.
Investors should wait for a wider margin of safety before buying Yahoo shares, says Morningstar’s Rick Summer.
Yahoo's first-quarter results indicated that the company is still in the midst of a turnaround, and although there is a modest glimmer of hope in the company's Internet search business, we continue to believe the shares are fairly valued and would encourage investors to consider a wider margin of safety before investing. We do not expect competitive pressures to subside, and we question Yahoo's position relative to companies that we believe have a more compelling collection of assets, particularly Google (GOOG) and Facebook (FB). Our narrow moat rating and fair value estimate remain the same.
The quarterly results have very little impact on our revenue growth forecast for Yahoo's core business. Overall company revenue excluding traffic acquisition costs declined 1% versus 2012 on the back of particularly weak performance in the display advertising business, which declined 11%. On a more positive note, search revenue ex-TAC (38% of quarterly revenue) and other revenue (24% of quarterly revenue) grew 6% and 9%, respectively. While we continue to expect Google and Microsoft's (MSFT) Bing to command greater share than Yahoo in the search market, this segment is nonetheless important to our valuation and overall profitability for the company. We expect this line of business to track overall user engagement, although we believe smartphone adoption offers a particular challenge for the firm.
Operating margins remain largely unchanged from the prior year. The employee base has declined from 14,000 to 11,300, but given the lack of revenue growth and heavy investment in the turnaround, these cost controls are not generating meaningful operating leverage. As Yahoo fights to increase its relevance in mobile while stemming declines in user engagement, our current forecast for operating margin improvement may prove overly optimistic.
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