SAN FRANCISCO -- When Yahoo! ( YHOO) missed estimates during the second quarter, investors gave the company what amounted to a "Get Out of Jail Free" card. After third-quarter results are announced Tuesday, however, the struggling Internet giant might have to serve some hard time. Given the current weakness in online display advertising, the company can't help but feel some pain, especially because of its heavy investment in that area, where it is known as a market leader. According to the Interactive Advertising Bureau, total revenue generated from search ads in the first six months of the year was up 24% compared to the same period a year ago, but revenue from display ads was up only 19% from the same period a year ago. "Our channel checks indicate the market for display ads, particularly branded or CPM-based ads, continues to worsen beyond our prior expectations and from Q2 levels," wrote Bank of America analyst Brian Pitz in a research note. "Given the current market environment, we believe advertisers are likely to hold back on discretionary brand-building dollars in favor of measurable search and performance-based display advertising." Analysts expect Yahoo! to earn 9 cents a share on revenue of $1.37 billion, excluding traffic acquisition costs. Yahoo! is also up against an investor base that is growing increasingly impatient with its performance. During its second quarter, the company had the distraction of Microsoft ( MSFT)-induced proxy battle to blame, at least in part, for its earnings miss. On Jan. 31, Microsoft made an unsolicited bid of $31 a share to purchase Yahoo!. The deal collapsed even after Microsoft raised the bid to $33 a share. Amid all the merger talk, activist investor Carl Icahn added to the chaos by seeking to oust Yahoo!'s entire board. In the end, he settled for three seats, including one for himself.
Fast-forward to the present -- where Yahoo!'s stock price sits near five-year lows at $12.86, a far cry from what Microsoft had been offering, as well as a sharp drop from the $30 level it saw during the merger talks -- much to the disdain of shareholders. The only significant lift the stock has seen is when hopes of another Microsoft merger are renewed. But the software company recently put out a statement saying that it was not in talks with Yahoo!, sending the stock sliding again. Jefferies analyst Youssef Squali said he expects Yahoo! to guide to the low end of its full-year revenue forecast of $7.35 billion to $7.85 billion in light of the deteriorating macro environment. "Given a lack of visibility into fiscal 2009, we expect Yahoo! to focus on cost containment," he said, noting in his research that Yahoo! managers have been asked to find operating budget cuts of 15%. If various media rumors hold true, Yahoo! will announce more than 1,000 job cuts during its quarterly earnings report. That would come on top of the 1,000 cuts already announced by the company in January. Yahoo! declined to comment on the rumors. But the predictions aren't all bad. Squali anticipates that search advertising could be a relatively bright spot for the company as it migrates more of its ad spending to performance-based media -- an area where advertisers are loathe to cut in their budgets. Still, it will be tough to compete with Google ( GOOG), the reigning champion in search ads. Last week, Google posted an earnings beat in large part because of its ability to extract healthy revenue from its search ads even in a down economy.
Yahoo! has so far been unable to keep up with its rival, which goes a long way to explain why it recently entered into an agreement to outsource some online ads to Google. Yahoo! had estimated it would be able to generate as much as $800 million in annual revenue through the deal, along with other efforts to improve its search platform. But even that is move is up in the air. The U.S. Justice Department and the European Commission are currently scrutinizing the deal for any antitrust violations. Both Google and Yahoo! have agreed to allow more time for the review.