Yahoo! Inc. (NASDAQ:YHOO) has been on a hot conquest to buy out many small companies. While many technology columnists believe that Yahoo! Inc. (NASDAQ:YHOO) is attempting to turn its recent $1.1 billion buyout of Tumblr into a profitable business entity, I believe just the opposite. I believe that Yahoo! will benefit regardless of whether or not it turns a penny of profit from Tumblr.
Analysis of Tumblr
Upon close examination of the deal, many critics have pointed out that the user base of Tumblr is young and fickle, meaning that users may pack their bags and move on to the next social network (sort of like what happened to MySpace). That being the case, Yahoo! Inc. (NASDAQ:YHOO) can immediately start monetizing its Tumblr blogging platform through display-based advertising.
Now many of you are probably frowning because the web-advertising business model — while offering high gross margins — doesn’t provide nearly the revenue upside that alternative business models on the Internet have been able to. That is why some critics have advised investors not to invest into Yahoo! because the company’s recent acquisition could burn through shareholder capital that could have been used elsewhere.
Why is Yahoo! pursuing an acquisition-based business model?
The reasoning falls under Generally Accepted Accounting Principles. Now, I’ll try to explain the reasoning in layman’s terms (if you get lost, don’t worry because I’m going to summarize the results in the following paragraphs).
Basically, what Yahoo! Inc. (NASDAQ:YHOO) is currently doing is cutting back on its research-and-development-related expenses. This, therefore, increases the amount of net income the company is able to record on its income statement. However, it doesn’t end there.
The cash that’s recorded as net income is also recorded as assets on the balance sheet (earnings accrue on the balance sheet). What Yahoo! does after recording net income is use the cash on its balance sheet to buy out other companies. When Yahoo! Inc. (NASDAQ:YHOO) buys out another company, the buyout doesn’t show up as an expense (even though it shows up on the cash flow statement, a buyout affects Yahoo’s! balance sheet rather than its income statement).
So by diverting cash from research and development and putting it towards M&A, the company is able to accomplish two goals. First, it is able to report a higher amount of net income. Second, the company could potentially generate higher amounts of revenue and net income from the businesses it acquires, or Yahoo! sells-off its stake at a later point for an exceedingly enormous profit. Yahoo! has done this in the past with its $7.1 billion sell-off of its Alibaba stake; Yahoo! Inc. (NASDAQ:YHOO)’s original cost-basis was $500 million (entry-point).
The company has been able to cut sales, general, and administrative costs by 27.6% over the past five years; likewise, the company cut research and development costs by 27.5% in the same period. Following that, the company re-directed that cash into mergers and acquisitions, which resulted in a 28% increase in the amount of long-term assets. Buying long-term assets isn’t an expense based on GAAP accounting standards, which is why net income increased by 841.8% over the same period.
Yahoo! should be able to stick around
Yahoo! is in the business of buying companies and optimizing its pre-existing advertising business model. Marissa Mayer doesn’t plan on ruling the world with search or display-based advertising. What the company plans to do is leverage its intellectual property (primarily its Yahoo! Inc. (NASDAQ:YHOO) brand) and maximize the profit from its pre-existing businesses. After maximizing the amount of profit that can be made, the company plans to redirect the cash into an M&A business model.
Yahoo! is making some incremental market share gains against Google Inc (NASDAQ:GOOG) . In the latest ComScore report, Google has lost 0.6% of its market share against Yahoo! Inc. (NASDAQ:YHOO) and Bing!
The loss in market share is attributable to Microsoft Corporation (NASDAQ:MSFT)’s recent advertising smear campaign: “Don’t get Scroogled.” Basically, the full effects of Microsoft’s smear campaign are starting to take their toll on Google Inc (NASDAQ:GOOG). Microsoft Corporation (NASDAQ:MSFT)’s gain in the search-engine space is also due to Microsoft Corporation (NASDAQ:MSFT)’s Windows 8 lineup, which uses the Bing search engine exclusively. Every Windows computer comes pre-loaded with Windows Internet Explorer. Windows Internet Explorer uses Bing search by default, which is why Microsoft is making some steady gains in search.
Despite the gains in search-engine market share that both Microsoft Corporation (NASDAQ:MSFT) and Yahoo! Inc. (NASDAQ:YHOO) have been able to enjoy, it doesn’t change the fact that Google is leading in market share by a fairly large margin, with Google Inc (NASDAQ:GOOG) holding onto 66% of the United States market. Google reported 21% year-over-year growth in revenue in its latest quarterly earnings release along with a 15.8% gain in earnings. Therefore Google’s strong financial performance offsets the loss of market share.
Other upside catalysts include Google Inc (NASDAQ:GOOG)’s 400% gain in sales from its Android marketplace year-over-year due to having 70% of the global mobile market under its control. Google’s recent roll-out of Google Fiber could be an even greater contributor to the company’s revenue stream going forward. Wearable computing could take-off in the coming decade, becoming a multi-billion-dollar industry. Google remains a healthy company despite losing market share.
Yahoo! Inc. (NASDAQ:YHOO) resembles a well-run hedge fund. The current CEO continues to emphasize an M&A business model. This involves cutting costs, buying businesses, and gradually improving its search and media services. The company’s current strategy seems to be effective at generating revenue and net income growth.
The article Yahoo! Operates More Like a Hedge Fund originally appeared on Fool.com.
Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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