Yahoo! Sags on Microsoft Scare

Yahoo! (YHOO) sank 5% Thursday under the weight of an analyst downgrade and the prospect of a looming confrontation with big customer Microsoft (MSFT).

The Sunnyvale, Calif., media giant saw its stock slip $1.77 to $34.63 after Smith Barney Citigroup analyst Lanny Baker cut his rating to hold from buy. Baker, citing the company's rich price-to-cash-flow estimate, said he made the move after the stock passed his price target. Yahoo! is up 63% in just three months.

Baker's decision to cut his rating on the stock stands in stark contrast to the mania that took hold of many analysts during the last Internet stock run-up, around the turn of the century. Then, many analysts raised their ratings and price targets and then raised them again as shares continued skyward, in spite of the apparent disconnect between stock action and investing fundamentals.

On the other hand, Baker did raise his price target Thursday, to $36.50 from $33, even as he cut his rating. Baker is long Yahoo!, and Smith Barney has done noninvestment banking work for the company.

Meanwhile, Microsoft unveiled a new search page on its MSN property and released a trial version of its own search technology. Baker cited the MSN situation as a primary concern for Yahoo! investors in coming months.

"On the risk side, our primary area of concern remains Yahoo!'s search relationship with Microsoft's MSN property, although this risk has not changed recently and our downgrade stands separate from this factor," Baker wrote. MSN is a big customer of Yahoo!'s pay-per-click Overture search unit, but the company has been pushing ahead with its own search engine, fueling speculation it will soon drop Overture in a setback to Yahoo!.

That said, Baker remains largely sanguine on Yahoo!'s prospects. The company is due to post second-quarter earnings next Wednesday.

"We expect Yahoo! to show continuing strong revenue growth and attractive operating leverage" in its second quarter, Baker wrote. "We remain positive on Yahoo!'s long-term growth prospects and exemplary execution, and think the company still has many currently-fallow opportunities to expand its advertising and subscription revenue in coming years."

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