When a company releases their earnings and revenue numbers to the public and then holds a video conference call for analysts, those that pay attention usually come away with a much clearer picture as to the prospects of said company. Yahoo (YHOO) did just that after the market closed yesterday, and I for one came away from it all with, if anything, a less clear picture initially than I had going in.
When an earnings release contains mixed messages, I find it is often better to wait and watch the market’s reaction before acting, then to trade that reaction. Usually, market dynamics will have a large influence on whether traders focus on the good news or the bad, and the other side of the coin can get undervalued.
In the fifteen months since Marissa Mayer was appointed CEO of the then struggling search and tech company, Yahoo’s turnaround, in market sentiment if nothing else, has been remarkable.
Following a price drop on results from the last “pre-Mayer” quarter, the stock has been on a sustained upward path, more than doubling from those lows around $15. The new CEO has been aggressive in pursuing the turnaround, acquiring companies at the rate of more than one a month, and seeing the number of users increase significantly since her tenure began. Most importantly, EPS increased by more than 50% year on year in each of the first two quarters of this year.
Then came Tuesday’s news… Revenue fell about 1% from last quarter to $1.08 Billion. EPS of $0.34 were again down compared to last year’s $0.39, but marginally better than expected. Forecasts for both 2014 revenue and EPS were lower than Wall Street had anticipated, at $1.18-1.22 Billion and $400-420 Million. Yahoo announced a re-work of their deal to sell shares in Alibaba, requiring them to release only 40% of their shares initially, compared to 50% before.
YHOO closed Tuesday at $33.38, and, after some volatility as each story unfolded, finished yesterday at $33.09. Following initial euphoria, the stock sold off sharply, as the 3-day chart below shoes, and that sell-off has continued early this morning.
Given that YHOO is, as I said up over 100% in just over a year, that reaction is almost inevitable. Some of the rise is undoubtedly as a result of a $1.7 Billion share buyback program, but there have also been a lot of buyers around, and most people interested in the stock seem to be long already, so it comes as no surprise that the market has focused on the bad news, rather than the good. There will, understandably, be some profit taking as progress slows.
In my opinion, however, this drop is a buying opportunity for those that have missed out so far.
I have a lot of admiration for Ms. Mayer, as it seems that not only can she run a company, but that she also has a rare knack for managing Wall Street’s expectations. When she took over and the stock price was depressed, she set about giving analysts what they wanted, a share buy-back and acquisitions to put cash to work, along with an initial agreement to monetize the Alibaba holding. Now, as expectations have begun to outpace reality, a downward revision in the forecast for next year has brought them back into line.
Some have focused on the drop in earnings from last year and are suggesting that Yahoo is having trouble monetizing products. Mayer made no secret when she took over, however, that she considered her first job to be getting the products and corporate culture right. Significant progress has been made in those areas, so I expect the company’s focus to shift to improving cash generation, particularly from mobile platforms. The acquisition of a number of companies specializing in mobile technology would indicate that they have, in fact, had an eye on that goal all along.
The lower forecast for 2014 looks bad on the surface, but even if you don’t believe there is an element of expectation management to it, there is a strong case for not over-reacting. The reduction in shares to be sold at Alibaba’s IPO is significant. Not only does it allow shares to be sold at a potentially more advantageous price, but also, as Stifel pointed out in their analysis, in a more tax advantageous manner. They estimate that this translates to a $1-2 increase in the value of YHOO shares, offsetting the downward revision in 2014 outlook.
In many cases, Wall Street’s reaction to news, even earnings reports, is based on more than the news itself. In this case, the selling following a mixed bag of stories coming from the Yahoo release and earnings call seems to be based more on market positioning than the actual numbers. This leads to the conclusion that the drop will be temporary, and investors who missed out this year could do well by buying YHOO while it is cheap.