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 after the market's close Wednesday, has Wall Street's blessing as the beneficiary of a rising tide in online advertising.

Analysts' reports going into the earnings call 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.

Now, all the company has to do is put to rest some lurking concerns about overvaluation -- including that of minority-owned Yahoo! Japan -- and competition from privately held Google.

Yahoo!'s shares -- which hit a 52-week high of $50.99 on Monday -- fell $1.22 Tuesday to close at $48.77.


For the record, the consensus of analysts surveyed by Thomson First Call is for the company to post first-quarter earnings per share of 11 cents, and operating income, before depreciation and amortization -- formerly known as EBITDA -- of $161 million.

The First Call revenue forecast is $501 million -- a net revenue figure, actually, which excludes the traffic acquisition costs that Yahoo!'s Overture Services subsidiary pays to other online publishers as their share of Overture's pay-per-click advertising revenue.

But that consensus number may reflect some underpromising on the part of analysts in the expectations of some overdelivery. Deutsche Bank's Jeetil Patel, for example, forecast in a note Monday that Yahoo! would report revenue of roughly $520 million -- ahead of his own estimate of $503 million -- and EBITDA of $175 million to $180 million, beating his published $165 million prediction.

Typical of the warm feelings toward Yahoo! on the Street is a report issued last week by American Technology Research's Mark Mahaney, who initiated Yahoo! with a buy rating and a $64 price target. Citing a bullish outlook for Internet advertising, among other factors, Mahaney called Yahoo! his top buy recommendation among large-cap Internet companies -- for investors with a 12-month time horizon. (Mahaney's firm has no banking relationship with Yahoo!.)

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 54 cents in earnings per share for 2004 by 5 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.

Multiplication Tables

Mahaney 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!, says Mahaney, 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!.

In an illustration of how Google could make life hard for Yahoo!, Google last week introduced the early version of a free email service that gives users huge amounts of storage space, compared with Yahoo!'s free email service, in return for advertising linked to the content of a user's email. But Mahaney thinks the risk to Yahoo! from Google's new service is minimal.

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.

In a follow-up note Tuesday, Mahaney said Yahoo! would have to significanly beat estimates and raise forecasts for the stock to trade upward following the earnings release. More likely, he indicated, the shares will trade downward, in line with a prior pattern of "buy the mystery, sell the history."

Meanwhile, on Tuesday, Schwab SoundView's Jordan Rohan cut his rating on Yahoo! from buy to neutral, though he kept his price target of $56. While Yahoo!'s operating fundamentals are strong, Rohan questions the run-up in shares of Yahoo! Japan, of which Yahoo! holds a 33.5% stake. The value of Yahoo! Japan per Yahoo! share has zoomed from $3 to $23 in less than 18 months, says Rohan. Yahoo! Japan's valuation, which Rohan pegs at 87 times forward EBITDA, "is beyond all practical and reasonable valuations," says Rohan, and would be still be fully priced at half current levels.

Rohan's firm hasn't done banking for Yahoo!.
This story was originally posted April 1 and has been updated to reflect subsequent events.

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