“Nobody would pay 50$ for a stock worth 18$.” This pithy comment was directed at Microsoft Massively Undervalues Yahoo! published here last week. The comment was motivated by this conclusion:
… [Yahoo!] optimal revenues of $13.4 billion would point to a market cap of around $78 billion based on a value/revenue ratio of 5.81. With 1.39 billion shares outstanding this suggests a price in the mid $50 range.
What are “optimal revenues?” Those are the revenues Yahoo! would generate if the earnings from the last sales dollar were equal to the cost of producing it. Or, in microeconomic-speak, the point where marginal revenue equals marginal cost. I apply this theory to the analysis of financial accounting data for public firms in my book Competing for Customers and Capital. Competing in a space with Google and Microsoft over the most recent four quarters Yahoo’s optimal revenues were nearly double its actual revenues of $6.8 billion.
Most of the pundits, including the Deal Professor at the New York Times, agree that Yahoo! has limited options:
Throwing yourself on the mercy of Microsoft not to go hostile appears to be another loser of a strategy. And while you can find some tie-up or other maneuvers to stall Microsoft or make any acquisition more expensive for them, it doesn’t look good. We eagerly await your next move given your limited options. Surprise us!
How could Yahoo’s CEO dramatically change the direction of his company? Certainly not by joining Microsoft to compete with Google in a lost battle for leadership of the search- advertising market. But maybe by competing with Microsoft in the battle for your desktop. My analysis led to these questions:
HAVE YOU HEARD THE BUZZ[WORD]?
On February 12, 2009 Kevin Maney published this article on Seeking Alpha: A Tangible Reason Microsoft Needs Yahoo. He began that post by saying:
Want a glimpse of Microsoft's future without some radical shift like buying Yahoo? Take a look at this piece entitled Forget Word: Thirteen Online Word Processors.
But buying Yahoo to protect the desktop franchise will only marginally broaden the moat Microsoft has built to maintain control of end users. It won't stop Google and the others from attacking its desktop franchise from all sides.
Near the top of that list was a short description of Buzzword. Clicking on this link sends you to a preview. An unexpected touch is that this preview document is open for alternation so you can test its functionality online. Among the apparent advantages of Buzzword are the ability to collaborate with co-authors and an extremely friendly user interface. Their UI was friendly enough to motivate my giving it a try. As a result I wrote this post in Buzzword.
The companies said in a statement that they would work on a number of joint projects, including the creation of an online service to convert Web content into PDF (Portable Document Format) files and a toolbar that would add access to Yahoo Search and other features to Adobe Reader, the company's free PDF client.
More recently the two companies created another project aimed at the search market. On November 28, 2007 they:
... launched Ads for Adobe PDF Powered by Yahoo!, an opt-in service that enables online commercial publishers to drive new revenue by including timely, contextual ads next to Adobe Portable Document Format (PDF)-based content.
These experiences working together, when added to their similar provenances and innovative cultures, provide the foundation for merger discussions:
The two companies are largely complementary in technologies and solution portfolios. Both work in the creation of Internet content. YHOO, however, lacks apps. ADBE, with its rich suite including Flash, Dreamweaver, and Acrobat, a portfolio of corporate customers and powerful developer community, would fill this gap.
ADBE would profit from YHOO’s immense distribution network. Such a broad and deep distribution channel could provide the linked companies the mass and depth to challenge MSFT’s dominance in the productivity apps market (Richard Lewis, personal communication 15feb08).
Jerry Yang might approach Shantanu Narayen (or Charles Geschke and John Warnoc) to initiate merger discussions off the record and under the media radar. Narayen may be the best bet to broker this deal since he, like the co- founders, is a technologist with a vision. In an interview following CEO Bruce Chizen's resignation Narayen said " ... we are one of three or four companies in the world who can make the Web experience better than it is today." I wonder if he considers Yahoo to be among those companies:
Narayen stated, in a 2005 Business Innovation Insider interview, that he admires Yahoo! as a company for its capacity to innovate. As President and COO, he drove Adobe's innovation and expansion into new markets (Richard Lewis, personal communication 16 Feb 08).
If he belives Yahoo! is one of those companies who can make the web experience better Narayen may be the right guy to run the merged operations.
500 MILLION EYEBALLS
Mr. Yang in his February 13, 2008 letter to Yahoo! shareholders stated that:
Yahoo! is one of the most recognizable and admired brands in the world. We have over 500 million users (nearly 1 out of every 2 internet users worldwide). Our goal is to grow visits to key Yahoo! starting points and properties, where users enter the Internet, by 15% per year over the next several years.
As the following table of Alexa data shows, Mr. Yang's goal is a stretch if it's to be reached through search advertising alone. Last week only 14% of visitors went to Yahoo! to search for something. Which pales by comparison to Google's 60% of visitors using search.
But the reason for Yahoo's top rank among internet users is due more to the number of page views per day (12.9) than to it's reach (27.85%).
Recently Adobe made acquisitions that transformed it from a major player in the design space to an industry-wide challenger with a growing range of software products. For example, the company's acquisition of Macromedia, Inc brought:
... together some of the industry’s strongest software brands and most ubiquitous technologies, and accelerates Adobe’s strategy to provide a powerful software platform that scales from mobile devices to enterprise servers.
This broad product range represents an asset base unparalleled in the digital world. But more important in the motivation for a merger was Adobe's October 1, 2008 commitment to acquire Virtual Ubiquity and its online collaborative word processor:
Adobe Systems ... today announced that it has signed a definitive agreement to acquire Virtual Ubiquity and its ground-breaking online word processor, Buzzword ... [that] will ... enable fundamental improvements in how people collaborate on documents ...
HOW DO YOU LIKE THESE APPLES?
People spend a lot more screen time creating documents than searching for things online. Yahoo's email leadership is largely responsible for its leadership in page views per day. Yet email requires far less screen time than more elaborate documents. These documents require even more time than watching videos on YouTube!
As I type this I've become aware that a substantial chunk of my screen's real-estate is occupied by a gray panel immediately to the right of the page. And there's a black strip across the top of the screen immediately following the "Help" command that's also unoccupied. These provide perfect venues for targeted ads.
But, wait! Would I allow targeted ads to appear in my private Buzzword document processor? My first reaction is "No Way!" But on second thought, I allow Google to place its responsibly targeted ads in similar spaces around my personal g-mail page! The real value would be if those screen spaces were filled not just with Google-like AdWords, but with links to stuff that would be useful in writing this article. Like the latest price of the stock tickers that appear in this document. But this would:
Call for Google-styled "cloud computing" that delivers something of value to you beyond the application functionality ... collaboration and 6 GB of online storage might work...and would be a nice (free) competitor to Microsoft's Groove (Edward Strong, personal communication 15feb08).
Just think for a moment about monetizing Yahoo's eyeballs with the now empty spaces around Adobe's Buzzword and other ODP's (online document processors) coming down their pike.
WHO WOULD PAY $50 FOR AN $18 STOCK?
The the first two lines in the following table compare YHOO's actual with its optimal market share, sales revenue , cost of revenue , enterprise marketing expenses, and EBITDA for the most recent four quarters. In a strategic group with Google and Microsoft the company's actual market share was 8.4% compared with an optimal market share of 16.5%. Its actual sales revenues were $6.8 billion compared with optimal revenues are $13.4 billion.
That optimal sales revenue of $13.4 billion is what drove my conclusion that investors would price Yahoo! in the mid $50 range -- if management optimized enterprise marketing expenses at $6.7 billion. Yahoo's historical value/revenue ratio [P/S ratio] is 5.81. Assuming this historical multiple still applies, the company would be worth around $78 billion if it optimized earnings. With 1.39 billion shares outstanding that points to a price of $56.
The third line in the table above,+ ADBE, reports the results of simply adding YHOO and ADBE numbers together without any synergies or other assumptions. Their combined market share of group revenues jumps to 14.7% yielding sales revenues of $10.0 billion. Assuming the merger would earn Adobe's value/revenue multiple of 6.10 their market cap would be around $60 billion, or $44 a share. The bottom line in the table above +ADBE at Optimal sales of $14.39 billion leads to a share price around $63. These values pretty well bracket that mid $50 price.
On January 31, 2008 Yahoo! closed at $19.18 with a market cap of $26.66 billion. Last Friday it closed at $29.66 with a market cap of $41.23 billion. Could the $14.57 billion difference be used as "bridge money" by Yahoo! in negotiating a deal with Adobe.? Its market cap last Friday was $19.89 billion.
If investors priced the combined companies in the mid $50 range it would be a sweet deal for everyone. And Microsoft would be off the hook! What do you think?
Thank you for visiting. As always I welcome your comments.