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One Net Stock That Isn't Poised to GoTo Zero

Advertising weakness? We scoff at your advertising weakness.

In a quarter when companies online and off are reporting ad revenues that are flat at best, pay-per-click search firm GoTo.com (GOTO) reported a 20% sequential revenue jump for its second quarter. It also posted a bottom line that was better than analysts' expectations and raised revenue estimates, targeting sales of $320 million in 2002, up from the Street's expectation of $250 million.

GoTo's numbers, released Wednesday evening, indicate that at least one company has cracked the code of how to make money with Internet advertising. In GoTo's case, that means operating a search engine in which advertisers compete for top placement by deciding for themselves how much they'll pay to be listed in the search results. Advertisers, who pay only when a user clicks on their listing to visit their site, are listed in the search results in order of how much they've agreed to pay per click, with the highest bidders appearing at the top.

With analysts piling on to praise the company on Thursday, GoTo's shares jumped $2.36 to $23.51 in afternoon trading.

Going Higher

For the quarter ended June 30, GoTo reported $62.5 million in revenue, up from $21 million one year earlier and $52 million in the first quarter of 2001.

GoTo's net loss was $2.9 million, or 6 cents per share, compared with a $20.3 million loss in June 2000, or 42 cents per share. Analysts surveyed by Thomson Financial/First Call had been expecting a 17-cent loss per share.

The company's earnings before interest, taxes, depreciation and amortization were just ahead of break-even, compared with an EBITDA loss of $10.6 million in the second quarter of 2000. GoTo says it expects to report actual net income in forthcoming quarters: $1 million, or 2 cents per share, in the quarter ending Sept. 30, and $19 million, or 31 cents per share, for full-year 2002.

Below the Headlines

Several other numbers by which analysts judge the company seem headed in the right direction. The number of paid introductions rose from 314 million in the first quarter to 323 in the second. The average price that advertisers paid per click rose from 16 cents in the first quarter to 19 cents, though it's still down from the 23 cents that advertisers paid in the quarter ended June 30, 2000.

Active, paying advertisers in the U.S. rose from 42,000 to 45,000. And the percentage of revenue that GoTo paid to other companies to operate its service on their online sites declined from 67% in first quarter of 2001 to 59% in the second. Those payments to affiliates such as AOL Time Warner (AOL) take the biggest slice out of GoTo's revenue on its way to the bottom line; GoTo forecasts they'll drop to 55% for all of 2002.

GoTo's pay-for-results revenue model is key to why it hasn't suffered the way other Internet advertising-based firms have, says Darren Chervitz, director of research for Jacob Asset Management. Referring to the ad industry term "cost per thousand," which denotes how much advertisers pay for consumers simply to be exposed to ads -- not to click on them -- Chervitz says GoTo "never really had to deal with CPMs falling through the floor." Says Chervitz, "They were always click-oriented. I think that appeals to people. They only pay for what they get." Chervitz's firm, which has owned GoTo in the past, doesn't hold the stock now.

Eggs and Baskets

Chervitz notes, however, that since GoTo exited the shopping and auction-related ventures it had going earlier this year, the company has now put all its eggs in the search basket, with all the risks that such a concentrated revenue stream implies. He also points out that the company faces some uncertainty over its affiliate programs with companies as big as AOL and Microsoft (MSFT), because upcoming contract expirations mean GoTo will have to renegotiate terms. "It's going to be interesting to see, when some of these deals come up for renewal, who has the negotiation power and what kind of arrangements they're able to nail down," says Chervitz.

GoTo CEO Ted Meisel says the company already has factored renegotiations with companies including AOL into its 2002 forecast. "We respect AOL's size and clout in the marketplace," he says. "What we think, though, is we have an even better service to offer them than we did the last go-round."

Though GoTo faces the threat that it may someday face stiff competition in the paid-search business from a large, deep-pocketed competitor, Meisel says he doesn't think it's an immediate threat. GoTo, he says, has achieved a critical mass, similar to eBay's (EBAY), that puts most competitive threats behind it. He adds, however, "I think we'd be remiss if we thought we'd be done [with competition] forever."

So the story is good. For investors, though, a crucial issue surrounding GoTo is valuation. At Thursday's prices, GoTo's shares are trading at 76 times expected 2002 earnings.

Is that too much to be paying for an Internet media company that hasn't blown up? Well, just like GoTo's advertisers, no one's forcing stockholders to bid that high.

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