Yahoo's Panama Pleases Investors

The long-awaited upgrade to the portal's search-ad system will launch Feb. 4. The Street cheered the announcement—but will it be enough?

After struggling for more than a year to catch fast-growing Web giants such as Google and MySpace, Yahoo! isn't out of the woods yet. But it may finally be seeing some sunlight through the thicket.
On Jan. 23, the Internet portal reported fourth-quarter profit that handily outpaced expectations as sales rose 13%, to $1.7 billion. Profit fell 61%, to $269 million, from a year ago, when Yahoo logged a gain on the sale of a China operation, but the 19¢-a-share profit easily beat analysts' 13¢ prediction. Initially, that wasn't enough to thrill investors, who swiftly knocked the stock down about 2% in extended trading, thanks to a muted forecast for a 14% rise in sales this year.

Momentum

But as soon as Chief Executive Terry Semel mentioned that a long-awaited improvement to Yahoo's search-ad system, known as Project Panama, would roll out earlier than expected, the stock reversed course and shot up more than 5%. The rally reflected the relief of investors who already were betting the worst could be over for Yahoo and were watching for any sign to the contrary. Shares have risen 7% since the start of the year and have been up as much as 10% this month. That follows a 35% swoon last year.

Panama, originally scheduled to launch last year, is Yahoo's attempt to close a sales gap with Google. Yahoo's search ads produce far less revenue for advertisers because the company's formula for running ads is based solely on how much advertisers bid on search keywords—the words that trigger the placement of an ad alongside search results. By contrast, Google takes into account how many people click on those ads, so they end up being more relevant to searchers—and elicit two or three times as many clicks as ads on Yahoo.

For the past two years, Yahoo has tried to improve the performance but has run into delays getting Panama out the door. Now, the new platform goes live in the U.S. starting Feb. 5, followed by international markets, starting with Japan in the second quarter. Yahoo wouldn't say how much it expects Panama to improve search revenue besides promising that it would see a "double-digit" increase in revenue per search in the second half. "We expect to see revenue impact to begin in the second quarter and gain momentum throughout 2007," Semel said in a conference call with analysts.

"Transition"

Already, advertisers are champing at the bit. Despite Google's dominance in search ads—or perhaps because of it—companies crave an alternative so they're not overly dependent on Google. Despite some advertisers' difficulty learning the new system, early reviews of Panama from advertisers and agencies are positive, with many saying the system is easier and faster to use than Yahoo's current system. "We're definitely hoping it will help even the playing field," says Adam Kasper, senior vice-president and director of digital media for MediaContacts, a digital ad agency.
Panama is not the only upside opportunity in the coming year. Yahoo's deal to sell ads on eBay, its agreement with a newspaper consortium to run job ads online, and a partnership with ad network Right Media to sell space on less-trafficked Yahoo pages all could kick in this year. "There's some real tangible business catalysts," says Rob Sanderson of American Technology Research, who has a buy on the stock.

Even so, Yahoo is far from home free. Semel himself tacitly acknowledged as much by using the word "transition" to describe Yahoo's likely performance this year. That's usually a code word for a tough year, but it also may be an attempt to manage expectations at a time when Google's momentum shows little sign of slowing and Yahoo faces challenges on a number of fronts.
For one, Yahoo's growth in the first quarter, often soft post-holidays, could slow considerably. The company says first-quarter revenue will rise only 8%, thanks in part to higher costs to drive traffic and Panama's only partial impact on the quarter.

Getting Social

Indeed, Panama could take a while to have an impact. Advertisers need to learn how to use it, and the formulas Yahoo uses for determining the quality of the ads will need to adapt to what users end up clicking on. "Investors are betting that Panama will save the day," says Scott Devitt, an analyst with Stifel, Nicolaus & Co. in Manassas, Va. "It may, but there's no proof that Panama is working. You're betting on something that is at least six months out" in terms of bottom-line impact. Even then, it's unclear how great the impact will be. "Panama will improve things," says Ellen Siminoff, CEO of search marketing optimization firm Efficient Frontier and a former Yahoo executive. "It's just a matter of how much vs. expectations."

And while Panama may improve how Yahoo makes money on search, the company is still losing ground in search in the first place. Yahoo's share of Web search queries fell slightly from November, to 23.6%, according to market researcher Nielsen//NetRatings. Google, meanwhile, captured 50.8% of searches.
Yahoo's mainstay display-ad business also is under pressure. In the third quarter, the company surprised investors with an unexpected slowdown in display advertising. It blamed that slowdown partly on the rising popularity among advertisers of social sites such as MySpace, whose traffic overtook Yahoo's recently by one measure.
One key for Yahoo will be finding a way to generate revenue from its own social Web initiatives, such as the photo-sharing site Flickr, the Web-bookmarking site del.icio.us, and its Yahoo 360 service. "If they're not able to use those communities as strategic assets, they're useless," says Sandeep Swadia, vice-president of strategic markets for corporate-search service FAST Search & Transfer. Problem is, "fundamentally, communities don't want commercial interruptions."

Yahoo will have to make this happen with a shuffled management deck. In December, the company announced the exit later this year of Chief Operating Officer Dan Rosensweig and the elevation of Chief Financial Officer Sue Decker to head a publisher and advertiser division. A search for someone to head a new audience division is under way. But for now, it's up to Semel to return Yahoo to its former yodeling glory.

BusinessWeek