Google Clues in Yahoo's Numbers

A close sifting of Yahoo's report will yield important clues on the strength of search advertising.
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Ten years ago, if you'd asked someone, "

Yahoo!

(YHOO)

or

Google

(GOOG) - Get Report

?" you would have been met with a blank stare, at best.

Here in 2005, it's an entirely reasonable question and one that Wall Street is taking up as the two search giants prepare to announce their earnings for the quarter ended June 30.

Yahoo! announces its earnings first, after the market closes Tuesday, but the two premier online ad houses have built such a rivalry that it's hard to talk about one without talking about the other. That's especially true in Yahoo!'s case, as Google's surging stock has been on many an investor's mind in the past three months.

But although the two companies are going head-to-head in one of the fastest-growing markets in the tech world, there are important distinctions that are splitting investors and analysts on which is better.

In short, Yahoo! offers much better transparency, a broader array of revenue streams thanks to its banner ads, and deeper ties with the blue-chip advertisers that are finally warming up to Internet advertising. Google, by contrast, is almost entirely dependent on search-related ads, which is where the strongest growth has been, especially in international markets.

One analyst who prefers Yahoo! to Google is John Janedis, an analyst at Banc of America Securities, a firm that has performed underwriting services for Yahoo! in the past year but not for Google. Janedis has a $43 price target on Yahoo!, which closed Monday at $36.58. And contrary to the crowd of analysts whose price targets on Google lie between $300 and $360, Janedis' Google target is a low $230.

The reason for the discrepancy, Janedis explains in a research note, is that search advertising grows sluggish in the summer, while branded advertising remains strong.

"Heading into the second-quarter earnings season, we continue to favor Yahoo! over Google given Yahoo!'s exposure to both search and branded advertising (seasonally strong in the second quarter), but we acknowledge the success Google has had in leveraging its brand equity in garnering market share within search."

Yahoo!'s experience with major advertisers is helping it win big campaigns such as

General Motors'

"employee discount" blitz and opening movies such as

The Longest Yard

and

Fantastic Four

. Those advertisers, Janedis notes, "have used Yahoo's network extensively and we think the company is relatively better positioned to benefit from the secular shift of traditional ad dollars into online."

In the second quarter, the 31-analyst consensus is for a profit of 13 cents a share, up from 8 cents a share in the year-ago quarter. Net revenue (that is, total revenue from ads less traffic acquisition costs) is forecast to reach $882 million, up 45% from a year ago.

Yahoo!, which has beaten earnings by 2 cents a share for the past two quarters, saw revenue grow 55% in the first quarter.

Even Google fanatics will be keeping a close eye on Yahoo!'s report, because it will offer the first coherent intelligence on just how much money is being spent on search ads. Such intelligence has been in short supply, leading some analysts to predict significant gains in spending on search ads and others to forecast a more troubling decline.

While Janedis says that "our proprietary pricing data indicates that keyword prices fell to the midsingle digits" during the quarter, Imran Khan, an analyst at J.P. Morgan Securities, argued, "Based on our 4,000-keyword pricing analysis as well as industry channel checks, we believe average keyword pricing may have been up approximately 5%." J.P. Morgan has an underwriting relationship with Yahoo!.

The difficulty in figuring out whether keyword prices are rising or falling has as much to do with the lack of a standard methodology -- analysts conduct their own informal canvassing -- as with the state of flux in keyword use. After an initial focus on a few thousand keywords inflated their prices, advertisers grew creative and experimented with new, harder-to-track keywords.

Given that lack of transparency in search pricing (neither Google nor Yahoo! will give early hints on pricing trends before their earnings reports), it's not surprising that analysts are leaving plenty of room for surprises.

Most are betting the surprise is likely to be on the upside. "Based on strength in the company's marketing services businesses, both search and branded, we expect Yahoo! to report results above consensus estimates," says Heath Terry, an analyst at Credit Suisse First Boston, which has an investment banking relationship with Yahoo!.

So, Yahoo! could start off this quarter's Internet earnings reports with a loud bang. Or -- who knows? -- maybe a big fizzle. For now, Wall Street is betting on the bang. In any case, it should make for a suspense-filled week of earnings announcements -- and increase the chance of volatility in the sector.