Yahoo Under Repair

Baldwin Louie — Mon, 12 Feb 2001 14:00:00 -0800

In January, during Yahoo (YHOO)'s most recent earnings call, President Jeff Mallett singled out FinanceVision as a point of light in an otherwise dark forecast. FinanceVision, a 10-month-old experimental financial news network, is located deep inside the company's Santa Clara, Calif., headquarters. Only when you reach a small clearing in a maze of cubicles that serves as FinanceVision's nerve center do you realize how small it all is.

It's obvious that Yahoo hasn't invested very heavily in this part-time CNBC knockoff that broadcasts news and commentary live over the Web. When asked in October how many people are working on the network, executive producer Eric Scholl swept his arm to indicate the 10 or so desks in the clearing and said, "This is it." And it clearly isn't enough to help Yahoo through its current woes.

After appearing almost invincible in the midst of the crumbling dot-com economy, Yahoo, arguably the mightiest Internet pure-play of them all, announced that it expects to take a big hit in earnings this year. The bad news raises questions about the long-term survival of even the strongest Internet brands, but it hardly comes as a surprise. A company that last year relied on a single source - advertising - for 90 percent of its revenues is bound to run into problems in tougher economic times. Yahoo has dabbled in a number of smaller projects that would help it diversify its revenue stream but never with the urgency required to capture a new market. The company remains largely a one-legged stool.

Through most of its life as a public entity, Yahoo was a success story, the Internet's most remarkable child prodigy. The portal has consistently shown a profit since the fourth quarter of 1996, making its stock one of the few pure Internet plays many institutional investors would buy - an Internet blue chip. According to Media Metrix, Yahoo reigns as the world's second-most-visited portal behind America Online, an accomplishment that has placed the company at the very center of the Internet Economy. Even as the dot-com advertising market tanked last year, Yahoo's brand remained solid, attracting an impressive amount of advertising from traditional retailers.

Yet not even Yahoo could maintain its momentum forever. In January, the company announced that while it expects a modest rise in revenues, profits will fall 10 percent to 30 percent, short of the 18 percent growth that analysts had expected. The company's stock has dropped 84 percent from last year's high, as if Yahoo is nothing but a niche b-to-b company with a suspect future. Its largest rival, America Online, is now part of the behemoth AOL Time Warner (AOL), which combines the country's most popular online property with Time Warner's content and extensive cable network. Not surprisingly, the Wall Street rumor mill is working overtime, casting Yahoo as a tarnished but still valuable Web jewel ready to be added to the crown of some mainstream media firm.

No one is counting out Yahoo yet. But the question looms whether this giant, like IBM (IBM) and Microsoft (MSFT) before it, has seen its day in the sun. The mighty Yahoo now seems like so many other Internet companies in search of reliable new revenue sources in highly competitive markets. Over the past two years, fat and happy Yahoo dabbled with projects such as FinanceVision. Now the company must get serious about diversifying its business if it hopes to regain its mantle as the bluest of Internet blue chips. The question is whether it's too late.

Yahoo has always been an advertising story, and until recently it's been a damn good one. The pitch back in 1995, advanced by Yahoo and every other Internet company skilled at attracting users but not necessarily revenues, was that the portal was like the early pioneers of television. Just as advertisers spent billions a year to broadcast their message to TV viewers, they'd spend billions to reach the visitors drawn to a particular Web site. Yahoo, with $1.1 billion in revenues last year, was the first company to prove that a business could be built primarily on online advertising.

As Yahoo's brand grew, inking an advertising pact with the portal was a sign that a dot-com had arrived. The reasoning was pure Internet: Cutting a deal with Yahoo wasn't about advertising a product or a service to consumers so much as advertising your existence to venture capitalists. A company can buy a banner ad on Yahoo, sponsor a section of the site or buy "placement," which allows businesses to target ads to people based on their keyword searches. Yahoo's "anchor tenancy" deals let companies set up shop in the portal's online shopping mall, which translates into advertising revenues and commissions for Yahoo.

By 1999, so many would-be customers were flocking to Yahoo that the company's representatives barely had to pick up the phones. Of the roughly $8 billion spent on online advertising last year (a figure just shy of the total dollars devoted to ads on cable TV), Yahoo grabbed one out of every eight dollars. The demand for space on its site meant that Yahoo could be unyielding on price and other terms. The company dictated where an ad would appear on its site and even wrangled over who owned the behavioral data generated by tracking a visitor's movement after clicking on an ad. At its height, the stock for the 6-year-old company was trading at more than 1,000 times earnings.

Correction:
A previous version of this story misstated the amount of transaction fees Yahoo made during the first three quarters of 2000. Yahoo didn't reveal that figure, but said it enabled $3 billion in transactions made by its members during that time.

TOKYO - Shortly after announcing that it would cease production on Dreamcast, Sega announced a strategic partnership with Palm (PALM), under which the Japanese videogame maker would provide games for Palm's handheld computers.

The detail of the alliance will be announced later, but the company said Sega's offline and online game contents will be available on Palm V and VII platforms this year. On Monday, Sega announced an alliance with Pace Micro Technology (PIC), a U.K.-based group, whereby the companies would jointly develop set-top boxes using Dreamcast technology, in order to go after the market of broadband gamers.

In addition, Sega said that closing its Dreamcast hardware business would probably cost the company about $685.5 million this quarter.

Isao Okawa, Sega's president and chairman, missed the press conference because of a cold. He issued a statement to the effect that he would donate his personal assets, worth about $728.4 million in stocks, to help cover the group's extraordinary loss.

Sega had predicted a net group loss of about $202 million, but now expects a group net loss of about $500 million for the fiscal year ending in March. The company said it hopes to secure additional bank loans.

"I feel mortified," said Hideki Sato, VP of Sega, after the press conference. "We wish we could have continued to do our hardware business. But the market environment is changing too rapidly. We realize now that this is not the era that we can just stick to one business model."

Sega had put its Dreamcast console at the center of its Net strategy. The machine would have competed against Microsoft (MSFT)'s Xbox and Nintendo's GameCube, both of which are expected to launch soon.

Despite bold price cuts, Sega has sold just 6 million units worldwide, including 2.7 million in North America. The company had hoped to sell a million more units by March. Sega was losing about $100 on each hardware sale.

Since late last year, the company has reportedly been a potential buyout target of Nintendo or Microsoft, although the company has denied such speculation. The company has also denied rumors that Okawa might step down as president and CEO.

On the Tokyo Stock Exchange Wednesday, Sega shares closed at 1690 yen ($14.52), up 45 yen or 2.74 percent from Tuesday's closing price.

Cracks in the Yahoo facade were starting to show before Yahoo's troubling earnings report in early January. The dot-com collapse had shrunk the Internet advertising landscape. According to the Internet Advertising Bureau, online ad spending declined 7 percent between the second and third quarters of 2000, the last period for which statistics are available. "[Yahoo's] revenue has really been juiced up by dot-com spending, and that is going to dry up," Lehman Brothers analyst Holly Becker said in October. "I'm concerned that it will take longer than most people expect" for Yahoo to pick up the slack from the dot-com fallout. A full one-third of Yahoo's revenues are generated by pure-play dot-com advertisers, and many of them will be unable to honor their contracts.

A softening in the advertising market also means that Yahoo can no longer play dictator with customers, who find they now get far more favorable terms. At the start of 2000, Yahoo was charging clients $9 for every 1,000 people who viewed an ad. Now, Yahoo is charging as little as $3 per 1,000 visitors, according to Tribal DDB's Tim McHale. (A Yahoo spokeswoman disputes this assertion, claiming ad rates have stabilized and in some instances gone up.) Where once a major portal deal was considered mandatory for any company harboring big dreams, it's now widely viewed as too expensive even at bargain-basement prices. "I don't have anyone coming in here saying, 'Get us on Yahoo,'" says David Sable, CEO of Impiric, a direct marketing firm that helps companies buy portal ads.

Even analysts, who in the fall were saying that they could find nothing wrong with Yahoo's addiction to ad dollars, are now changing their view. Three months ago, Solomon Smith Barney's Lanny Baker argued there was nothing wrong with turning Yahoo into the next NBC, which gets 100 percent of its revenues from ads. But now Baker says Yahoo needs to diversify or it will be vulnerable to the cyclical nature of the market. Nineteen of the 34 analysts who follow Yahoo rate the stock a "hold" or a "sell" despite its depressed price of $33 per share as of Jan. 19.

Should Yahoo have moved more aggressively to diversify sooner? Yahoo's Mallett, a boyish-looking, fast-talking 36-year-old, says no. "We saw a third of the way through 2000 that the dot-com environment was changing, the advertising environment was changing, and we made the appropriate adjustments."

And - counterintuitive as it seems - Yahoo could benefit from the downturn. As smaller dot-coms close their doors, some advertisers are likely to turn to established sites like Yahoo. "We think we are in a position now to take even more share out," says Mallett.

But others aren't too sure. Bear Stearns analyst Jeffrey Fieler, for instance, faults the company for failing to act quickly when advertising revenue started to dive. "In retrospect, you could be critical of them not doing that," Fieler said. "But in early 2000, people were throwing money at the company. It's hard to be disciplined in that environment."

It's uncanny how bad news helps focus a company. "It's been on the radar for years, the fact that the advertising model can't be relied on," says a former Yahoo software developer who recently left the company after four years in its search division. But finding new revenue hadn't been an urgent matter within Yahoo, he said. Only a few months ago top executives had downplayed the importance of diversity. Following Yahoo's gloomy financial forecast in January, however, executives seem to be changing their view, albeit slightly.

"Were going to diversify our revenue mix by growing our commerce and enterprise business by adding more channel partners and more service offerings," says CEO Tim Koogle.

Indeed, one reason the company expects to be far less profitable this year is that it will spend roughly $100 million on new business initiatives in 2001, meaning that two-thirds of Yahoo's new expenditures in 2001 will go to these efforts. Yahoo, says Baker of Salomon Smith Barney, is finally "putting their money where their mouth is."

Among the initiatives will be more fee-based premium services, possibly in the entertainment and finance fields. Since September 1998, Yahoo has hosted an auction site that enables users to list and sell items without a charge, but only since last month has the company imposed a listing fee. (Yahoo Auction's listing fee is still much cheaper than eBay's (EBAY).) Meanwhile Yahoo, which has long charged users for online bill payment and extra mail storage, added fee-based job listings in December 2000.

Yahoo is also more aggressively pursuing the corporate market. In June, the company started selling a Web-page customization service to corporations interested in creating individualized mix-and-match portals for employees, customers and partners. But only in the past month has Yahoo begun to push the service hard. Meanwhile, a number of software companies, including Microsoft, Oracle (ORCL) and SAP, entered the customized-portal market long before Yahoo. Plumtree Software (dossier), one privately held company established in 1997, unofficially sells itself as "the Yahoo of corporate portals."

Yahoo "has been noncompetitive in the corporate-portal space as far as I'm concerned," says David Yockelson, a Meta Group analyst who specializes in Internet business plays.

Shopping has been another disappointing area for Yahoo.

Since 1998, Yahoo has collected a transaction fee from retailers that sell goods through Yahoo Shopping. AOL, however, has done a far better job capturing dollars from this nonadvertising revenue stream. Yahoo enabled $3 billion in transactions during the first three quarters of 2000, according to Rob Solomon, director of Yahoo Shopping. But AOL facilitated nearly $5 billion in the third quarter of 2000 alone, according to the company. "Our goal is to be the largest enabler of online transactions," Solomon says. It's a noble goal - but quite a tall order given AOL's lead.

FinanceVision and ShoppingVision, a program launched in November that showcases new products for sale through the site, represent an initiative of a different type. Like many of the features Yahoo has added to its pages over the years, these two seem intended to draw more visitors to the site, and therefore add to the advertising revenue stream. What's new about the FinanceVision project in particular is that Yahoo is breaking from its agnostic middleman role as neither the creator of the content on its site nor the owner of the delivery mechanism.

Yahoo denies it, but FinanceVision clearly places the company in the news-gathering business. Rather than hiring financial journalists or those with television experience, the company selected two Yahoo employees to be among the show's anchors after holding a companywide audition. Not surprisingly, the show's production values are barely a cut above Wayne's World. Following the CNBC format, the anchors interview analysts, CEOs and financial journalists representing other outfits, and Yahoo reporters provide dispatches from Wall Street throughout the day.

FinanceVision is aimed at investors hipper than the run-of-the-mill Wall Street suits. But now that more people watch CNBC than CNN, competition for viewers seeking real-time news from the Street is fierce. About all that differentiates FinanceVision from its competition, however, is its low production quality, the funky glasses worn by one of its anchors and the Yahoo brand itself. Yahoo refuses to reveal viewership figures for FinanceVision, nor will it say how many advertisers it has. Perhaps as broadband becomes more widespread, FinanceVision will evolve, too, but for now it's hardly must-see Web TV.

That's about all that Yahoo has in the pipeline. The offering might sound thin, but Mallett claims he isn't worried. While no one is suggesting that Yahoo move away from its advertising model, Mallett is surprisingly unapologetic about continuing to rely heavily on so volatile and unpredictable a revenue source. "We fundamentally believe stronger than ever in the advertising business on the Internet. End of story," Mallett says. "The ad pie is still growing. We think we're going to take a bigger piece of that."

Yahoo's overdependence on advertising is even more problematic given the recent AOL Time Warner merger.

The new megacorporation, a media sprawl that includes Web sites, magazines, cable, film studios, music labels and the world's largest proprietary online community, provides a far more appealing one-stop destination for advertisers than Yahoo. America Online's sales force has a wide arsenal at its disposal, from the world's most popular portal to mass circulation publications such as Time and People to global news station CNN. It's too early to say for certain, but the speculation is that the Dulles, Va.-based giant might offer package deals from a smorgasbord of media outlets, a particularly compelling selling point to the largest mainstream advertisers already comfortable with print and TV and just now starting to look to the Web for exposure. Yahoo, furthermore, might have a tough time getting business from the many advertisers that already have an established relationship with Time Warner. Why would these companies shift their allegiance, especially now that AOL Time Warner can offer deals such as free product placement in a Warner Bros. movie for any company making a large online-advertising purchase?

There are advantages to Yahoo's standalone approach, however. For instance, because it's not tied to any single access provider or cable system, it can strike deals with anyone. The company has secured an impressive array of distribution deals over wireless devices, and it is expected to have similar success with broadband providers. Moreover, Yahoo is also likely to pick up new business from the current crop of AOL partners, such as CBS Marketwatch, that compete with Time Warner and therefore might not want to pair with a rival's online parent.

"Once you tie up with a particular access provider, you tend to shut off your opportunities to partner with other access folks," says Jeffrey Housenbold, who was a vice president at AltaVista (dossier) until recently. He believes Yahoo, because of its size, will be perfectly fine on its own.

Still, Wall Street has been abuzz with rumors that the company is seeking an old-media company with which to partner. The precipitous decline in Yahoo's stock has only added to the speculation. The Walt Disney (DIS) Co. had been one favorite in the rumor mill, as have various European and Japanese telecoms given Yahoo's overall strength overseas. [See "Looking for Help From Abroad".] In mid-January, the word on the Street was that Viacom (VIA), the huge media conglomerate that owns CBS and MTV, was eyeing the portal. Wall Street liked the idea - Yahoo's stock spiked 24 percent in just two days - but Yahoo's management has consistently said the company is not looking to merge with another media company; it still believes in its standalone strategy. Yahoo, Mallett maintains, can still become "the world's largest interactive business and consumer services company," all by itself.

It's easy to overstate Yahoo's predicament. The company has amassed a $1.7 billion war chest and has filed paperwork seeking approval to sell another $1 billion in securities. Its brand has attained remarkable international reach for so relatively young a company: In only six years, Yahoo has expanded into 24 countries, reaching roughly 60 percent of Internet users worldwide. The company claims more than a 90 percent renewal rate among its advertisers and boasts 60 million registered users and 180 million visitors per month. That's a 66 percent increase over last year's registered user base, and a 50 percent spike in overall traffic in one year's time. But the cost of going public after only 13 months of existence is that Yahoo must endure its growing pains in the harsh light of public scrutiny. If the company is failing, it's a failure as measured against expectations.

Mallett says that nonadvertising revenues might account for as much as 20 percent of Yahoo's 2001 revenues. Many observers think it's dangerous for Yahoo to remain a one-trick pony. But Mallett dismisses speculation that Yahoo needs a certain balance between advertising and nonadvertising revenue, calling any nonadvertising revenue a "secondary concern."

Redpoint Venture partner Geoff Yang acknowledges that investors need to be concerned with Yahoo's overall reliance on advertising. But he has confidence that Yahoo will pull through these hard times just fine.

"They've proven time and time again they're the company to beat on the Web," Yang says. "They're smart. They're dedicated. They're focused. I'm confident they'll figure it out. They're going to be one of the survivors."

Still, for the time being, the exclamation point after Yahoo's name has been replaced by a question mark.

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Yahoo Under Repair