Facebook Inc (FB): What Had Yahoo! Inc. (YHOO) Investors Spooked?

On the face of it, Yahoo! Inc. (NASDAQ:YHOO)’s most recent earnings report was quite encouraging. EPS beat the consensus by a generous margin, while revenue was mostly flat. Initially, the stock was up a bit following the release. However, the enthusiasm quickly faded as investors dug a little deeper through the report.

Shortly after the initial pop, the stock sagged again. What had investors worried about the once-great internet giant? Declining ad revenue was likely the cause.

Facebook PhoneAd Revenue Woes

Q1 2013 EPS came in at $0.35, well above the $0.24 figure analysts were expecting, and up 36% from the same period a year ago. At first glance, this looks pretty good. GAAP income from operations was up 10%, with GAAP net earnings rising to $390 million for the quarter. Yet analysts were quick to point out that the company was earning more from its Asian holdings, especially from its 24% stake in Alibaba, a Chinese marketplace website which is delivering staggering top line growth.

Earnings from investments for the quarter totaled nearly $216 million, easily outpacing its operating income of $186 million. One analyst was quoted as saying that “they are making more money (as) an investment house.” While this isn’t necessarily a bad thing, Yahoo! Inc. (NASDAQ:YHOO) is not an investment house.

Instead, Yahoo! relies on advertising revenue for much of its income, which is where the pain really lies for this earnings report. Yahoo’s core business of display ads, which accounts for roughly 40% of its total revenue, tumbled 11% to $402 million. Analysts were expecting a dip of 9%, or revenue of $432 million for the business.

Still, CEO Mayer, who saw the stock price of the company rise some 50% under her leadership, remains confident about the company’s ability to turn things around, remarking that these things take time. She expects the company to see some growth by the second half of the year. Analysts remain cautious on the 2013 outlook, which many believe is too optimistic considering the dwindling ad revenue.

Competition

It makes sense to compare Yahoo! Inc. (NASDAQ:YHOO)’s results to those of two other internet titans, Facebook Inc (NASDAQ:FB) and Google Inc (NASDAQ:GOOG), since they all rely heavily on advertising revenue to fuel growth. Simply put, both of these companies are doing a lot better at growing advertising revenue than Yahoo! is.

Facebook, for its Q4 2012 report, delivered advertising revenue of $1.33 billion, representing 84% of their total revenue and up 41% compared to the same period a year ago. Excluding foreign exchange translation, this figure would have been up 43%. Mobile revenue was doing particularly well, contributing 23% to total revenue compared to 14% in Q3.

Google is also growing the top line a lot faster. For Q4 2012, the company delivered consolidated revenue of $14.42 billion, up 36% year-on-year. Revenue from Google-owned sites increased 22% year-on-year and revenue from sites in the Google network grew 19%.

While aggregate paid clicks were up some 24% compared to the same period a year ago and up 9% sequentially, costs per click declined 6% year-on-year and 2% compared to the previous quarter. Google seems to be having more trouble than Facebook in the mobile advertising arena however.

Valuations and Metrics

Despite the trouble Yahoo! is having, the stock still seems priced very reasonably. It trades at only 7.26 times trailing earnings, a bargain compared to Google’s 24.63 and Facebook’s monstrous P/E of nearly 1,800. The price-to-sales is perhaps a little high at 5.25, but the price-to-book is only 1.82.

The operating margin of 16% is on par with the industry, but dwarfed by Google’s 27%. The return on equity, on the other hand, is very good at 29%. Finally, the company does have a very healthy balance sheet, due in part to its Asian investments. The company has almost no debt on the books, and some $4.18 billion in cash.

The Bottom Line

While Yahoo beat big-time on EPS, its ad revenue had investors worried. CEO Marissa Mayer is clearly working hard on turning around this ailing business, but like all great projects, this may take a while. A bright spot in the report is the company’s Asian holdings, which are proving to be very profitable, in fact more so than its operations. Looking at valuations, the stock is priced very reasonably compared to competitors, although this alone is not enough to provide further upside for the stock. Cautious investors will be looking very close at how well the company is able to beef up advertising revenue this year.

The article What Had Yahoo! Investors Spooked? originally appeared on Fool.com and is written by Daniel James.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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