Yahoo – Fire alarm

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Yahoo seems to be fanning the flames.

• As part of the sale of the core business, Yahoo has been obliged to circulate memorandum that once again lay bare the harsh realities of Yahoo’s predicament.
• These documents look bad with hefty declines in both revenues and profits forecast this year but it is worth remembering that figures were announced to the market at the Q4 15A results in January.
• I think that Yahoo has got itself into this mess because usage has moved away from fixed to mobile and Yahoo has done a very poor job of evolving its portfolio to match.
• For example in Q4 2015A, Yahoo was happy to report that it had generated $291m in revenues from mobile devices.
• Unfortunately, RFM estimates that if it had properly evolved its Digital Life assets into mobile in an easy and fun to use way, it could have generated $2.3bn in revenues.
• Consequently, I think that Yahoo’s inability to address mobile has led to its missing out on 88% of the opportunity that it is open to it.
• This is a major reason why the core business is performing so badly as usage and monetisation are moving to areas where Yahoo is unable to follow.
• Yahoo’s response to this has been very disappointing.
  • First. Buying Revenue. Yahoo has effectively been buying traffic in order to prop up the popularity of its online properties.
  • This is why GAAP revenue will be roughly flat this year but this goes hand in hand with a huge increase in Traffic Acquisition Costs (TAC).
  • Effectively Yahoo is masking the declines in its revenues by buying revenue generating traffic from other web sites and services.
  • This means that the revenue genuinely generated by Yahoo’s properties will fall by 14% this year to $3.6bn.
  • This is why Yahoo’s has to reduce costs, as falling real revenues are taking profitability with it.
  • Yahoo expects that 2016E EBITDA will decline by around 25% to approximately $750m
  • Second. Strategy. I think that the conjunction of McKinsey and Yahoo working on strategy has led to a misunderstanding of the market Yahoo is trying to address.
  • Yahoo has stated time and again that mobile is its future but the shuttering of games and (I think) maps has massively reduced its long-term growth potential.
  • This is because both of these are important parts of the Digital Life pie.
  • Furthermore, games is the single biggest segment and is also the segment where there is no big player making it something that Yahoo should have really considered going after.
  • Activision Blizzard understands how important this and is making its play for this segment with the acquisition of King Digital and its 500m monthly active users.
  • I think that Yahoo and McKinsey are looking at each asset or business on its own merits and not considering the bigger picture.
  • If Google was to think like this, then it would probably have shut YouTube and Maps which I think would have killed a significant piece of its search revenue.
  • Google understands that the value of a portfolio of integrated services is orders of magnitude greater than a jumble of stand-alone offerings.
  • I have long believed that YouTube and Maps are hugely valuable assets to Google as it monetises them through search using the data that they collect.
  • Yahoo and McKinsey have decided instead to fire 15% of the workforce and shutter a few activities which I think will only make a bad situation worse.
• As a result of these very disappointing responses, I can see revenues declining faster than the company anticipates, and I will not be surprised to see Yahoo take the knife again to its guidance.
• Yahoo’s valuation already values the core business at zero, but if it has begun to destroy capital and burn cash then it could easily be worth less than zero.
• This is how further downgrades could still result in a hefty slice of the valuation of the company being removed.
• This is why Yahoo remains a classic value trap and why there I fear that there is more downside even though the value of its investments in Yahoo Japan and Alibaba already meaningfully outweigh its enterprise value.
• Only a very brave investor would risk a position in Yahoo right now and I am not one of them.