Searching for a Tech Savior

Yahoo!'s earnings could help heal the sector's recent wounds.
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So are these good times or bad times for Internet stocks?

It's gotten harder to tell these past few months.


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have been tossing out the occasional small acquisition and new feature, yet investors have grown increasingly concerned that they're just not cutting the financial mustard anymore.

By the end of this week, everyone should have a better idea of just how bad or good things are getting: Yahoo!, eBay and Google are reporting their earnings (Amazon will report next week). First up is Yahoo!, the company that has the best shot of dazzling Wall Street with strong numbers.

"Yahoo! is the most interesting company," says Frank Husic, managing partner of Husic Capital Management. "It's a wonderfully run company, and it has the biggest opportunity to show capital gains."

Analysts polled by Thomson First Call are forecasting Yahoo! to post revenue of $796.8 million in the first quarter and EPS of 11 cents on a GAAP basis. A year ago, Yahoo! delivered 7 cents a share, beating the Street's estimates by 2 cents a share.

Any bit of good news would be welcome in the beleaguered Internet sector. Morgan Stanley's Internet Index is down more than 15% this year, trading at levels last seen nearly six months ago. Evidence in the previous quarter that margins at e-commerce companies were deteriorating was followed by concerns that search-related advertising was also seeing a slowdown in growth.

Two areas that aren't slowing much are branded advertising and banner advertising, where Yahoo! has a strong presence. While advertisers grow more cautious about advertising on radio and in print media, they are spending more than ever to brand themselves on the Internet. Online ads are expected to grow 30% this year, according to the Jack Myers Spending Forecast.

"Yahoo!'s branded advertising growth could potentially accelerate from 2004 levels of around 34% as traditional marketers increasingly turn toward the Internet," says Derek Brown, an analyst at Pacific Growth Equities, which has no underwriting relationship with Yahoo!.

Brown estimates that Yahoo!'s branded-ad revenue will rise 33% to $226 million, roughly in line with the growth rate for 2004, thanks in part to increased advertising among auto and consumer-goods companies such as

General Motors

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General Mills

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Yahoo! has said that the top 200 advertisers may have started sticking their toe in the Internet-advertising pool, but they are spending less than 2% of their advertising budgets online. If they like the results of a potentially more interactive medium, and one where ads are not just banners placed on a page but where brands are woven into sites through sponsorships, that ratio may improve. And for now, Yahoo! is seen as the prime venue for big advertisers to be seen on the Web.

A bigger wild card is Yahoo!'s search-related ads, which make up about 40% of its revenue. Search ads are an area where Yahoo! goes head to head with Google. Both companies have a strong insight into the pricing trends of search ads, but both have been equally silent on what they're seeing, leaving analysts all over the map on their own estimates.

"We see positive indicators from advertisers and the online ad agencies," UBS analyst Benjamin Schachter wrote in a report. "However, we continue to believe that search is supply constrained. It is the basic idea that you cannot force consumers to search for terms as much as you may want to advertise on them." UBS has an underwriting relationship with Yahoo!.

Imran Khan, an analyst for J.P. Morgan, notes that much of the growth in search is coming from desktop toolbars, which tend to lock Internet users into searching through one engine. He estimates toolbar-search revenue will grow 65% this year, well above the estimated 39% growth rate for overall search revenue. Yahoo! and Google control 95% of all searches conducted through toolbars, with Yahoo! having a dominant 51% share in the U.S. and Google a stronger 63% for non-U.S. markets. Morgan has performed underwriting for Google, but not for Yahoo!.

Yahoo! is positioning itself to be a player in a lot of emerging areas of Internet content. Not only has Yahoo! matched or beaten Google with every incremental search innovation that has emerged over the past year, it's been aggressively pushing into new areas such as social networking, video content and travel information.

"Yahoo! has its fingers in a lot of different areas and is well-positioned to benefit from a number of channels," says Brown. "The access side of the business, the deals they have with companies like




British Telecom


, is also a very stable driver for them. It's not as sexy as search, but it's solid."