When Overture Services (OVER) got hit by a big piece of bad news last week, a smaller piece of bad news got lost in the shuffle.
That's the contention of one analyst who follows Overture, the strong-performing pay-per-click search engine company that cut its earnings forecasts last week.
While investors punished Overture for Wednesday night's lowered guidance, they likely overlooked an acquisition that Google, the privately held rival to Overture, announced that same day. But Google's deal to acquire California software company Applied Semantics strikes additional blows to Overture's business, says Derek Brown, an analyst at Pacific Growth Equities.
Overture says Google's Applied Semantics acquisition isn't as significant as Brown makes it out to be. But as Overture makes acquisitions of its own to expand into new markets, the Google deal, at the very least, illustrates the competitive forces at play behind Overture's scaled-down expectations.
On Monday, Overture's shares dropped 20 cents to close at $10.70. The company's stock has dropped 35% since Wednesday night, when
Overture cut its 2003 earnings per share forecast from 63 cents to 42 cents at best.
At issue is the impact on the paid search business of Applied Semantics' transformation from a partner of Overture to a subsidiary of Google. As Google says in the announcement of the deal for the privately held Applied Semantics, the heart of Applied Semantics' products is technology that "understands, organizes and extracts" content from Web sites and other databases "in a way that mimics human thought."
A key application of this technology, says Google, is a product that enables Web publishers to automatically place online advertisements on Web pages on the basis of their relevance to the content of those pages.
That process is a critical element of a recently introduced service of Google's, which places advertisements on Web pages of certain Web sites corresponding to the content of those particular sites. Like Overture, which delivers search results based on the search terms that Internet users type into a search engine, Google branched into the new content-targeted business from selling advertisements keyed to the search terms people type into the Google search engine.
In a recent report, Brown argues that Google's acquisition of Applied Semantics guarantees that a meaningful source of traffic to Overture's search engine -- a domain parking business it operates -- will end with the current partnership in 2004, if not earlier. Applied Semantics, in fact, was one of Overture's top 10 affiliates in the fourth quarter of 2002. (
are Overture's biggest, feeding the company the traffic from which it derives a majority of its revenue.)
Furthermore, says Brown, Applied Semantics has been an important technology vendor to Overture, which has been developing its own content-based advertising system -- known sometimes as contextual marketing. "While others may eventually be able to provide
Overture with this technology/capability," writes Brown, "the acquisition is, at the very least, a setback for Overture's near-term platform expansion plans."
Brown has an underweight rating on Overture; his firm hasn't done any banking for the company.
Overture responds that Applied Semantics' role as a partner that generates Overture's traffic has diminished. "We do not expect this to have a material impact on revenue, if any," emails an Overture spokesman.
As for Applied Semantics' technology, it "is merely ONE of many technologies we have been testing as we develop our own contextual product," says the spokesman. Pure technology approaches such as Applied Semantics', he says, are inherently weak, and the company's forthcoming contextual advertising service will combine technology with human editorial processes.
Brown, in turn, counters that though Applied Semantics no longer fits Overture's definition of a partner, it still sends the company a significant amount of revenue-generating traffic.
Meanwhile, Overture recently completed its own acquisitions of AltaVista and Fast Search & Transfer's Web search business as part of its own effort to expand into other paid search areas such as paid inclusion, in which Web publishers pay to have their sites regularly checked for relevance by search engines. But Overture CEO Ted Meisel indicated last week that the acquisition-fueled paid search business was taking longer to launch than the company had expected.