Internet advertising looks like it will continue its recovery this year. And that's good news for Yahoo! (YHOO).The Internet bellwether, slated to report first-quarter results next Wednesday, started this week with a buy rating from American Technology Research, which cited a bullish outlook for Internet advertising, among other factors. Meanwhile, Credit Suisse First Boston, which rates Yahoo! an outperform, raised 2004 estimates for the company on the basis of faster-than-anticipated improvement in Yahoo's online advertising business. The research notes indicate that Yahoo! -- whose stock has more than doubled over the past year and trades at more than 90 times estimated 2004 earnings -- still hasn't worn out its welcome on the sell side. Yahoo!'s shares fell 32 cents Wednesday to close at $48.47. Initiating Yahoo! with a price target of $64, ATR analyst Mark Mahaney called Yahoo! his top buy recommendation among large-cap Internet companies -- for investors with a 12-month time horizon. (In other coverage initiations Wednesday, Mahaney assigned buy ratings to Amazon ( AMZN) and eBay ( EBAY), and a hold rating to InterActiveCorp ( IACI).) One of the key factors driving Yahoo! is the growth of Internet advertising, writes Mahaney. He forecasts overall growth in 2004 U.S. Internet advertising of 30%, up from 20% growth in 2002, though behind the fourth-quarter 2003 year-over-year growth rate of 38%. Branded advertising will grow 22% in 2004, Mahaney forecasts, up from 18% growth in 2003. Search ad growth -- through Yahoo!'s Overture subsidiary -- will be up 130% in 2004, thanks in part to local search and monetization of international search. Yahoo!'s EBITDA margin, or earnings before interest, taxes, depreciation and amortization as a percentage of revenue, will rise from 32.2% in 2003 to 38.8%, ahead of the 35.6% that Mahaney terms the implied high end of the company's guidance. And just as the company beat earnings guidance last year, he expects that Yahoo! will beat the current consensus of 53 cents in earnings per share for 2004 by 6 cents.
Among his caveats, however, Mahaney notes that Yahoo! is a high-beta stock and that it's trading at a high ratio of revenue to earnings, on the basis of generally accepted accounting principles. He says, however, that he prefers to look at Yahoo! on a multiple of free cash flow (generally defined as operating cash flow, or EBITDA, after capital expenditures and interest expense have been subtracted). That's because, Mahaney says, the FCF multiple, unlike GAAP earnings, captures the balance sheet efficiencies of Internet companies -- for example, limited requirements for both capex and working capital. Yahoo!'s current multiple of 26 times estimated 2005 FCF per share of of $1.33 "doesn't appear too aggressive." That 2005 figure, he notes, however, doesn't include stock option expensing. Another risk to Yahoo! is posed by the imminently expected initial public offering of privately held Google, an IPO that would give Google a bankroll for stiffer competition with Yahoo!. Through its search business, Yahoo! will generate $250 million in revenue from Microsoft's ( MSFT) MSN in 2004, or 11% of total estimated revenue; given Microsoft's public plans for developing its own search technology, it's reasonable to assume that Yahoo!'s Microsoft-related revenue will decline once the relevant contracts expire in 2005. CSFB's Heath Terry, meanwhile, on Wednesday raised his 2004 revenue estimate for Yahoo! from $2.26 billion to $2.3 billion, and increased his EPS estimate from 55 cents to 61 cents. For the first quarter, Terry raised his revenue estimate from $491.4 million to $505 million, and nudged his EPS estimate from 11 cents to 12 cents. (The Thomson First Call consensus for the quarter is for revenue of $498 million, EPS of 10 cents -- based on a range of 9 to 13 cents -- and EBITDA of $160 million.) Among the other positive trends in advertising, Terry notes a declining percentage of ads on Yahoo! that are house ads, suggesting less unsold inventory and higher pricing for ads. Industrywide, Internet advertising will grow 21% in 2004, he estimates. While per-click pricing on Overture has seasonally declined, Terry estimates, monthly volume of searches on Yahoo! have increased in January and February.