Yahoo's Search Profit Margin to Expand Offering Additional Upside to Stock

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Yahoo ( YHOO ), which competes with Google ( GOOG ) and AOL ( AOL ) in the search business, is seeing relatively stable profit margin of 42% since 2008 by our estimates, and we expect the margin to rise slightly over the coming years as Yahoo benefits from its partnership with Microsoft ( MSFT ). In 2009, Yahoo and Microsoft signed a deal whereby Yahoo will not only use Microsoft's search technology on its websites but will also keep majority of the ad revenues. Yahoo is also making efforts to control costs, by cutting its workforce, which should improve profitability in the short term.

From 2006 t0 2008, Yahoo's search EBITDA margin saw a steep decline from around 52% to 42% led by the sluggish economy causing companies to spend fewer advertising dollars. Competition also stepped up as search giant Google expanded its market share putting additional pressure on Yahoo and others.

While we expect Yahoo's search advertising EBITDA margin will rise to 44% in 2011 and remain at that level over the forecast period, Trefis members predict the search margin will cross 54%, representing an upside of 3% to YHOO stock. We currently have a Trefis price estimate of $17.88 for Yahoo's stock , ahead of the current market price of $16.91.

Microsoft Partnership Could Boost Yahoo's Search Margin in Near Term

Microsoft made a hostile attempt to buy Yahoo in 2008 for $47.5 billion but the deal did not go through. However, the two companies agreed to a 10-year deal to boost their online search and advertising businesses as well as create stronger competition for Google which dominates the online search and advertising market.

Through the Microsoft deal, Yahoo is expected to make more money as it's allowed to keep 88% of revenues from search ads generated from its website for the first five years of the contract while Microsoft absorbs most of the expenses. According to a study by digital media services company, this search alliance could boost ad rates by as much as 78% and that the long-term cost-per-click ( CPC ) rates for ads will stabilize at 13% to 23% above current levels. The higher rates imply that advertisers get a bigger search platform to reach consumers. (See: Microsoft Search Alliance Could Boost Yahoo Stock by 2% , Trefis, Sept 24, 2010)

Cost Controlling Initiatives Can Improve Margins

Yahoo has regularly cut its workforce in recent years. It trimmed 1,400 jobs in December 2008 at the peak of recession, 700 jobs in Q2 of 2009, and 650 jobs in December 2010. In the recent conference call for Q4 2010, Yahoo announced a layoff of another 1% of its workforce. We expect such cost-cutting initiatives will lift Yahoo's margins in the short-term. (See: Yahoo Focus on Cost Cutting, Needs Top Line Growth to Move Stock , Trefis, Feb 1, 2011) However, in the long-term, Yahoo has to focus on improving its top-line revenues to sustain its current margin levels.

Trefis Community Forecast

Trefis members expect Yahoo's search advertising EBITDA margin will increase from 48.4% in 2011 to 54.3% by the end of the Trefis forecast period, compared to the flat baseline Trefis estimate of 44% over the Trefis forecast period. The member estimates imply an upside of 3% to the Trefis price estimate for Yahoo's stock.

Our complete analysis for Yahoo's stock is here .



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: AOL , CPC , GOOG , MSFT , YHOO

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