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FOOL'S DEN
Yahoo! and the Dot-Com Meltdown

With the recent downturn in dot-com stocks, analysts and investors fear that online portals such as Yahoo! will be hurt by a reduction in sales of banner ads to cash-strapped online companies. In this excerpt from his recent quarterly Motley Fool Research report on Yahoo!, Zeke Ashton surmises that these fears are overstated and that, in fact, Yahoo! could benefit from the turmoil.

By Zeke Ashton (TMF Centaur)
August 22, 2000

With the recent well-publicized downturn in dot-com companies, Yahoo!'s (Nasdaq: YHOO) stock has wilted along with the rest of the sector. The July 7th downgrade of Yahoo! by Deutsche Bank Alex Brown analyst Andrea Williams Rice was based on the specific fear that reduction in sales of banner ads to cash-strapped dot-com companies would hurt big advertising sellers such as Yahoo!, America Online (NYSE: AOL), and Lycos (Nasdaq: LCOS). How close to reality are those fears? Let's take a closer look at the dot-com meltdown and how it could affect Yahoo!

First of all, fears of an ad sale slowdown have been greatly overstated. In fact, advertising on the Internet in the first six months of 2000 rose to $1.26 billion from $818.5 million in 1999, a 54% increase, according to research firm AdZone Interactive. And concerns that any dot-com-related slowdown would affect Yahoo! in the second quarter were largely unfounded, since Yahoo!'s average advertising contract is 225 days and often involves some up-front payments.

Yahoo!'s management has stated that about 10% of its revenues come from financially questionable clients. That's potentially $28 million or so in advertising sales that won't renew in the fall. Based on Yahoo!'s reported advertiser numbers, I calculate that the company added 300 new advertisers in the second quarter while losing 180. I suspect some of those 180 non-renewals may have been from the financially questionable clients. The company also reported that every one of the top 50 advertisers and 98 out of the top 100 renewed their advertising contracts in the quarter. These are very good signs.

Any weakness from reduced ad sales probably won't really affect Yahoo! until the third and fourth quarters, when the company opens up 2001 advertising sales. While it is likely that many of the former big-spending Internet companies will be tightening their fiscal belts, Yahoo! should make up for some of the loss by landing larger Fortune 500 and international accounts.

Tim Koogle noted in the company's conference call that 1999 Web-based advertising spending was about $4.6 billion. That number is projected to grow to $19 billion by 2002 and $26 billion by 2003. So any concerns about renewals from 10% of the advertising revenue base should be more than offset by the huge growth of the ad-spending pie. Although revenue growth might be slower than it would have otherwise been with the heavy-spending dot-coms, it just doesn't seem likely that the loss of those clients would be enough to seriously derail Yahoo!'s growth.

Let's look at the flip side of the dot-com meltdown -- how Yahoo! might profit from it. First, with the concern over the financial health of the dot-com sector, I would expect a flight to quality, in which heavy-spending ad clients would reallocate much of their ad spending from questionable Web companies to heavy hitters. Yahoo! and AOL would likely be the two major beneficiaries of any such behavior.

Second, with dot-com companies selling for fractions of what they were even three months ago, Yahoo! has much better leverage for acquisitions and venture investments. The acquisition of eGroups at $450 million might have cost much more at the same time last year. Ditto for Yahoo!'s three venture capital investments in the second quarter.

Finally, with the recent acquisition of Lycos by Terra Networks, Yahoo! has become an even more unique asset, a characteristic that generally creates a premium valuation. Yahoo!'s position as the bellwether stock for the Internet is now clearly established. Despite the recent negative market sentiment, the Internet still offers the potential for huge profits, and the number of blue chip companies in the sector has diminished. Growth-minded investors will likely still want to have some stake in the Internet, and if you are calling the roll of blue chip Internet pure-plays, the list pretty much starts with Yahoo!

From where I sit, as far as Yahoo!'s future prospects are concerned, the dot-com meltdown is likely to be short on cloud and heavy on silver lining.

Related Links:
-- Motley Fool Research Reports on Yahoo!
-- Yahoo! Discussion Board

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