Overture Backers See Little to Fear From Google

The curtain may one day fall at Overture Services (OVER) . But the show still has plenty of room for a long run.

So argues one investor in Overture, the Internet advertising company whose pay-per-click search engine business has made it a volatile stock over the past few months.

Short-sellers -- investors who bet that a particular stock's price will fall -- have cogently argued that the margins Overture earns by selling placement on Internet search results listings are at risk of being eaten away by Internet affiliates who run Overture's search results in return for a cut of Overture's advertising revenue.

But Ethan McAfee, investment analyst at Capital Crossover Partners, argues that the reports of Overture's demise are greatly exaggerated -- especially any demise at the hands of Google, the search engine Wall Street usually cites as the most worrisome competition for Overture. And McAfee's point of view is bolstered in part by some who have advertised with both companies.

Buffeted by news and rumors about deal with its affiliates, Overture's shares have ranged from a high of $43.15 to a low of $17.61 since the first of the year. The company's shares closed Monday at $23.90, up 40 cents.

Numbers

The central thesis to the bear case, which

TheStreet.com

has explored in detail, is that Overture will have to turn over a larger percentage of its advertising revenue to affiliates such as

Yahoo!

(YHOO)

and

AOL Time Warner's

(AOL)

America Online -- not the 55% it told Wall Street it would be paying this year, but something north of the 85% that advertising sales reps in traditional media turn over to the newspapers or broadcasters they represent.

That threat will be played out in the near term, they say, by negotiations between Overture and some of its top affiliates, which are likely to slice away at Overture's share of the advertising pie. Overture and America Online were due to extend AOL's affiliation agreement in March, but the companies extended their deadline until April 24. And Yahoo!, though it extended an agreement to affiliate with Overture through the second quarter of the year,

has been coy about whether it will extend that agreement, go with Google, develop its own pay-per-click engine or pursue some combination of those options.

The knocks Overture has taken in the market from the threatened loss of AOL's and Yahoo's business -- and the beating Overture would take if they lost either deal -- reflect the Web sites' leverage in these negotiations, say the bears: AOL and Yahoo! need Overture more than Overture needs them.

Leverage

But McAfee counters that the affiliates' bargaining position is shakier than Overture pessimists would have it. In these financially tense times, portals are likely unenthusiastic about putting at risk the relatively easy money they're getting from Overture, he says, and taking on the expense of launching their own services. And even if they could get a larger percentage of ad revenue from Google, says McAfee, the absolute dollars would be so tiny, it wouldn't be worth it. To use an extreme metaphor, would the portals rather collect 90% of the revenue from a kid's lemonade stand, or 55% of sales from Snapple?

Overture generated around $15 million in revenue for Yahoo! in the first quarter of 2002, estimates McAfee, up from zero dollars before the Yahoo!/Overture deal launched last fall, and amounting to about 8% of Yahoo!'s revenue for the quarter. "Yahoo! is in no position to abandon 8% of their revenue these days," he says.

Guessing that Yahoo! gets a 65% share of the ad dollars Overture reaps from Yahoo!'s site, McAfee supposes it would take two years and $30 million for Yahoo! to build up its own pay-per-click search engine to match its current revenue from Overture. That replacement revenue, he points out, would be offset by various pay-per-click operating expenses Yahoo! doesn't have to worry about now, such as research and development. "So maybe, at best, Yahoo! could gain 5% more by doing this in-house, but that would take years to get to that point," says McAfee.

Though AOL Time Warner presumably has larger resources, execs there are likely equally unenthusiastic about doing it themselves, says McAfee, given belt-tightening at the media conglomerate. "It's going to be a hard sell

internally," says McAfee. "If AOL wanted to do it, they would have done it two years ago."

Alternatives

Yahoo! and others, however, have mentioned Google as an alternative to Overture, especially since Google two months ago launched keyword-linked pay-per-click advertising similar to Overture's, called AdWords Select. Google is best known for its non-commercially influenced search engine results but has been introducing commercial listings adjacent to the unpaid ones.

But McAfee dismisses that threat. In recent days, to use McAfee's favorite example, if one types in "books" on Overture, the first listing -- and thus the highest-paying advertiser, by Overture's system -- is

Amazon.com

(AMZN) - Get Report

. Meanwhile, the top AdWords Select listing on Google was

Lou & Chris Books Plus, a cheesy-looking site linked to a hodgepodge of affiliate programs.

"Does AOL want that to be the top Web site coming up?" asks McAfee. "These guys

Google do not have a critical mass at all of the major advertisers." In addition, since Lou & Chris -- who link to Amazon, among other sites -- probably can't convert visitors to their site into buyers as well as Amazon can, they're likely paying less to Google than Amazon is to Overture.

Conversations with other users of pay-per-click Internet advertising indicate that the privately held Google, which doesn't disclose its revenue, is far behind Overture commercially. (This commercial analysis ignores a potentially huge barrier to Overture competitors: intellectual property. Overture has

launched patent infringement suits against Google and another search engine,

FindWhat.com

(FWHT)

.)

Russell Troutman, director of Internet marketing services at

Sales & Marketing Technologies, an Orlando-based Web design and marketing firm, says he's launched pay-per-click accounts for more than 100 clients with Overture, as well as many accounts with other providers of pay-per-click advertising. Though spending varies by client, Troutman estimates that clients are spending more than 90% of their money on Overture, with Google and other search engines splitting the rest.

Anthony Finta, a partner in the travel site

Caribbean-On-Line, says he's been using pay-per-click advertising on-and-off for three years. Finta says the last time he made a major buy, he spent $400 to $500 in a month on Overture. But clicks on his keyword ads on Google were so sparse, he says, he ended up spending "maybe $18" on that site.

A Google spokeswoman responds, "We are still ramping up with that program. We are pleased with the progress we've seen to date."