Search growth
Doubtlessly, search will continue to be a key area of investment for Yahoo!, and its partnership with Microsoft Corporation (NASDAQ:MSFT) will continue to have positive effects on its key search metrics. Consequently, Yahoo!’s revenue from search increased 9% to $1.61 billion in the fiscal year 2012, compared to $1.47 billion in 2011.
Microsoft partnered with Yahoo! to replace its search and ads engines under a 10-year deal in order to improve its Bing search platform. Under this partnership, Microsoft currently pays Yahoo! more than 85% connected with the Bing search ad sales. Bing currently holds less than 5% of the global market share, whereas Google search engine’s more than four-fifth market share still makes the latter the leader by a wide margin. Microsoft wants to dominate in search, but so far has remained unsuccessful at doing so.
Yahoo! is also improving the advertising quality on its search engine, which will explain how it was able to translate lower traffic into higher clicks in the fourth-quarter. If Yahoo! can maintain this performance, revenue from search is likely to grow even further in the future.
That said, I still think Yahoo! needs to improve its search interface design to make it more user friendly on both desktop and mobile. I believe that in the future search will be more user personalized, where search engines know exactly in what context users are searching for something. So I wouldn’t be surprised to see Yahoo! investing more into developing better personalization technology in the future.
Foolish bottom-line
After the bitter experiences with 5 CEOs in the last five years, it’s my view now that Yahoo! is finally on the right track under the leadership of Marissa Mayer. Revenue and earnings are improving for the company, and it seems both employees and investors are equally optimistic about the future.
Yahoo!’s share count has already fallen sharply from 1.4 billion in fiscal 2010 to 1.18 billion at the end of 2012, and considering management’s plan to spend a big chunk of the future cash flow on buybacks, this trend should continue. Yahoo! has historically managed mid-20’s cash flow margins — longer term, though, I believe the company can boost that margin into the high-20’s.
Moreover, I’m comfortable with a long-term revenue growth outlook of 2% to 3% on Yahoo!, along with a steady improvement in free cash flow generation. All told, I think Yahoo! can grow its free cash flow at a 4%-6% rate for the long term — discounting that back, it suggests a fair value of about $23.
Admittedly, that’s not a huge upside to today’s price, but Yahoo! is generally regarded as a top-notch company and its shares don’t often give investors a chance to buy at a substantial discount to a fair value. While I’m indifferent about buying Yahoo! at these levels — as the shares trade near all time high — I’d certainly consider a purchase if a broader market sell-off or periodic tech-overbought panic sends the shares down to the high-teens, as the shares present an attractive risk/reward there. Sub-$19 is where I will start a long-term position.
The article Yahoo! is Finally on the Right Track, But the Stock is Near Fair Value originally appeared on Fool.com and is written by Nauman Aly.
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