Despite the attention the media puts on new management, the fundamentals of Yahoo! Inc. (NASDAQ:YHOO) have not changed that much recently. Furthermore, the fact that the stock price continues outperforming NASDAQ shows that investors’ expectations are much higher than the value fundamentals dictate. But, high expectations cannot last forever. If Yahoo! Inc. (NASDAQ:YHOO) does not improve its fundamentals, the stock price will eventually start falling.
Yahoo! Inc. (NASDAQ:YHOO) needs revenue growth as soon as possible. But, is acquiring companies like Tumblr the solution?
When you buy a certain stock not because of its underlying organic value, but because of the ROI from some acquisitions it has made in the past, you are actually buying an IT fund. This is what Yahoo! Inc. (NASDAQ:YHOO) looks like. So, if we were to look at Yahoo! as a portfolio of investments, what is the acquisition of Tumblr adding to the portfolio?
Yahoo! Inc. (NASDAQ:YHOO)’s board approved a massive $1.1 billion all-cash deal to buy Tumblr. Notice that the size and “appetite for artificial growth” in this deal reminds us of the $1 billion Instagram acquisition by Facebook Inc (NASDAQ:FB), or the more successful $1.65 billion YouTube acquisition by Google Inc (NASDAQ:GOOG).
What is Yahoo! getting? Tumblr, founded in 2007, has 175 employees and more than 108 million blogs in its network. According to comScore, it had nearly 117 million unique users world-wide in March, up from about 58 million a year ago.
I tried to find some patents Tumblr possesses and could not find any significant information on the Internet. Therefore, as far as I know, Yahoo! is getting massive traffic: a big microblogging network, top 15 in the U.S., but with very weak monetization figures. They only made $13 million in revenue last year.
Now, what is the cost of this acquisition for Yahoo!? Yahoo! is paying a $300 million additional premium if we consider that the last time Tumblr raised money, in September 2011, the $85 million venture capital investment it received valued the company at $800M.
The upside is that Yahoo! is in a strong financial position at the moment. According to Yahoo! Finance, as of December 2012, the company had about $5.65 billion in total current assets (which include cash and cash equivalents, short-term investments, net receivables, and other current assets). The $1.1 billion investment will decrease the amount of total current assets by 19.6%, a considerable decrease in cash and other equivalents but it does not leave the company financially weak.
Tumblr’s real value
Tumblr has about 117 million unique users world-wide. This sounds like an enormous opportunity for profit, but massive amounts of traffic require high maintenance costs. Because there is no information available on the cost structure, it is hard to make any estimates, but it is a well-known fact that with the current revenue size, advertisement and freemium monetization approach, the firm is not profitable.
Some would say that the $13 million in revenue made last year was before Tumblr became more aggressive about advertisement. They expect to make $100 million in revenue this year, after all. It is too early to be sure about this, but keep in mind that Tumblr has one of the most expensive CPM in the industry and this could keep away many potential advertisers.
Furthermore, even if Tumblr manages to generate consistent revenue in the future, in order for Yahoo! to recover its $1.1 billion premium, they would need to make $1.1 billion in profits. Also, they spent $25 million in 2012 in operating expenses. But now, they have twice the traffic, so let us assume that operating expenses have increased by $15 million (I’m not saying they double because of economies of scale). You have $40 million in operating expenses.