BUSINESS BLOGS
BUSINESS BLOGS
category: business
07 Feb 2008

In Could Jerry Yang be that Much of a Yahoo?, I wrote:

If Yahoo! outsources search to Google, it only adds velocity to Google’s firepower, bear in mind, Google’s growth rate is falling. Google here needs Yahoo! more than Yahoo! needs Google. What Google needs, it the financial firepower and resources of Microsoft. Oh, it also needs MSFT’s execution track record and bravado.

Why? If Google and Yahoo! remain two stocks competing for shareholders’ money, and Google wins Yahoo!’s business, Google (the stock) will far outperform Yahoo! (the stock).

From a reader:

Huh? I use to think you had some smarts, but to say that google needs yahoo more than the reverse is stupid beyond belief. are you smoking crack? Last i looked google was still increasing revenue over 50% yoy vs. yahoo. secondly google needs microsofts firepower and execution? Uhhh.. you know google has about $15 billion which is close to microsoft and when was the last time you heard anything about groove or tellme? Or what about onfolio? I understand you are long yahoo but you have lost me as a reader with this post.

Usually I would simply reply in the actual post, but this is a very important point worth diving deeper into the question at hand.

If Yahoo! outsources search to Google, it’s a no-brainer: Google wins a lot more than Yahoo!

SHORT TERM: Yahoo! wins, by a bit. Google can’t believe its luck.

Yahoo! gets a short term bump by virtue of instant improved monetization. Say at most this represents a 25% boost in search revenues. Yahoo!’s total revenues are close to $7B, so the increase would not be 25% more than $7B, but 25% more of whatever search revenue is, maybe. There is nothing that guarantees that Yahoo! will get the same monetization rate as Google does on Yahoo!’s properties. Google’s monetization is what it is because over 50% of Google’s inventory are on search pages - where the propensity to click on a paid search result is higher than on content pages.

But, there’s one more thing people seem to overlook. Yahoo! was generating 25% less revenue per click than Google before Panama’s launch. Panama has launched, it’s a work in progress, but all signs suggest that the gap between Panama and Google have narrowed. The reason why Yahoo!’s revenues in search continue to lag considerably are simply because Google has been adding market share whereas Yahoo! has been losing it. So I do not even think Yahoo!’s short term boost is really going to be 25%, I suggest it would be 5-15%.

Lastly, we look at costs. The bulk of Panama’s costs have already been invested. Yes, Panama - and any IT initiative - represents an ongoing expenditure. But who are we kidding, the bulk of the investment in time, people and money has been invested. As such, the potential cost savings are not as considerable as any one would like to suggest.

In fact, since Google would retain 5% to 50% of revenues, then it’s as if the cost savings are written off.

MID-TERM: Google Wins

Mid-term, Yahoo! would see some improvement in revenue, but it would give up all of the data that Google would be collecting. This has been alluded to by John Battelle, too. In fact, much the same way that GE became the world’s most valuable company in the post-Industrial Age era, Microsoft - and potentially Google - have become so valuable because of all of the information they have in the Digital Era. Google has the runway (data mining) and platform (Internet) to become more valuable than Microsoft, over time (initially, we said by 2010). This is why Microsoft is throwing in the kitchen sink and will stop at nothing to win over Yahoo!

Back to the mid-term prognosis: within a month or two, Google’s market share in search will continue to grow; Yahoo!’s will become moot (even if it appears on the radar, it does not own the market share points). Microsoft will probably continue to lose relevancy. AOL and Ask.com - both relying on Google - will become obsolete in the discussion, too.

So, in the midterm, Google would technically own the Internet universe’s market share and Microsoft would own less than 10%.

Google would be the 21st century version of Microsoft, who in turn was the answer to Standard Oil, the 19th century monopoly.

But more importantly, it is not Google’s market share or revenues alone that instill fear in the competition, it is its high-flying stock.

Google’s stock has fallen from an all-time high of $747 to about $495. Google remains vastly profitable, with $5B of free cash flow and nearly $20B in revenues. Google - the stock - remains a powerful currency. But given that a stock is equal to:

Net Present Value of = Today’s Income + Tomorrow’s Potential

Then Google needs to maintain high growth rates to see a growing stock price. Google admitted that its growth is slowing down.

That is for year-over-year Q4 growth rates. Yearly, the same applies:

- Google’s 2002 revenues grew 409%
- Google’s 2003 revenues grew 234%
- Google’s 2004 revenues grew 118%
- Google’s 2005 revenues grew 92%
- Google’s 2006 revenues grew 73%
- Google’s 2007 revenues grew 56%

The numbers are so big, that it needs massive add-on’s to the real estate of search it powers.  Where, do you think, such growth could come from?  That’s right: Yahoo!

Visually, you get:

In other words, even if Google continues to generate $20B in annual revenues it won’t be enough to maintain such a lofty stock price increase.

It is the stock price increase that allows Google to use the stock as a hiring tool (otherwise the options will be underwater) and a M&A currency (otherwise buyers will ask for cash).

So ultimately, yes, make no mistake about it: if Google takes over Yahoo!’s search, within months, and definitely within a year, Google wins by a lot more than Yahoo!

In fact, Yahoo! loses because Yahoo! would be repeating a mistake it did in 2000 when it agreed to use Google’s search engine to power the queries on its portal.

The reason why Yahoo! would lose even more is because right now, ceteris parabus, Yahoo! is better positioned in Asia - the world’s fastest growing web market - than Google.

Over time, Yahoo! can grow to become more valuable than Google (yes, I said that) based on Asia alone. But with Yahoo!’s management in place, I doubt they can take over a Chinese restaurant, let alone the Chinese market.

LONG TERM: Google Dominates

If Yahoo! sells to Microsoft and remains a separate operating unit of Microsoft, then Yahoo! + Microsoft + aQuantive has a chance, but no certainty, of one day competing with Google. Google will continue to be the undisputed number one in the market in search (Google), video (YouTube), ad serving (Doubleclick), feeds (Feedburner), etc. etc. etc.

But with Microsoft providing cover, Yahoo! has a chance to remain relevant and grow. Alone, it cannot, history has proven that. That has a lot to do with management’s missteps, such as handing off search to Google in 2000. For some analysts and Monday Morning QBs to let Jerry Yang’s disdain and distrust of Microsoft blind them to the fact that Google taking over Yahoo!’s search operations serves Google’s interest more than Yahoo!’s shows their own lack of understanding of history and bias.

The final and most important consideration is that today, Google competes with Yahoo! for shareholders’ money. If I want to be exposed to the online advertising market, I can choose between Google and Yahoo! With the opportunity to merge with Microsoft, Yahoo! has increased its value (not only because of the $31/share offer). But by remaining independent, then Yahoo! is asking to remain Google’s whipping boy. By even considering outsourcing search and repeating history, then it is showing to be suicidal.

Yahoo! is better positioned for the next wave of growth in online advertising: display/banners and video. But Yahoo! lost its way. It is vulnerable. It won’t remain independent and of all of the options (Private Equity, sale to a strategic buyer), Microsoft is the one that can be taken from concept to reality. If that makes anyone unhappy, then the lesson is: don’t go public. Yahoo! had its IPO when it had a mere 49 employees, mushrooming once to a market cap of $97B during the peak of the dot com bubble. Those days are gone. Google seems to learn from history and realizes that it might one day too lose its place at the top of the perch. Microsoft certainly understands the cycle of innovation and how upstarts can one day upstage incumbents. Yahoo!’s Board is trying to retain what’s left of its old glory. But it has run out of time.

Is Yahoo! in the arms of Microsoft ideal? No. But Google taking over Yahoo!’s search unit is even less ideal, it is borderline criminal.

Sometimes, the enemy of my enemy is my friend. Other times, the lesser of two evils is the preferred course of action.

Note: Long YHOO. Love Google. Respect MSFT. I also owned stock in aQuantive before MSFT bought that.