Yahoo (YHOO): Q3 Stronger Than Expected

From Silicon Alley Insider: Yahoo Q3 Earnings Analysis
SAI Key Metrics Analysis (web-based spreadsheet)

KEY POINTS

Overall: Revenue is re-accelerating, and more importantly, search-monetization is improving (Revenue per Search increased 20%). Traffic growth was also solid (Earlier in the quarter, some Comscore data suggested that Yahoo's user-growth had peaked).  Margins declined, which is a concern, but costs are easier to control than revenue, and we expect management will focus on efficiency later in Q4 or in early 2008.  Bottom line: Company finally headed in right direction again.

Revenue ex-TAC at high end of guidance range. In light of display weakness through quarter and chaos at Yahoo, this is good news.  Overall revenue up 12% year over year, an acceleration from Q1 (7%) and Q2 (8%).

U.S. revenue growth accelerating, as a result of search monetization improvements and, surprisingly, display growth. The search news, especially, is very encouraging.  Search revenue on US "owned and operated" sites accelerated to better than 30% year over year, driven primarily by improved click-through rates (due to the new search algorithm).  Even display accelerated, with U.S. display up 20% (from low teens in Q2).  US revenue up 13% Y/Y vs. 5% in Q2.  On the negative side, International revenue decelerated to 9% from 15%.  This is puzzling, especially in light of favorable currency trends. Management blamed  the cleansing of crappy affiliates and says international search algorithm improvements should kick-in in Q4.

Owned and Operated sites (Yahoo sites) revenue continue to accelerate, which is also good news: Up 24% in Q3, vs. 18% in Q2 and 14% in Q1.  This segment contributes far more profit than the "Affiliates" so growth here important.  The Affliate network will contribute less than 10% of the company's revenue ex-TAC in Q4.

Guidance for Q4 essentially unchanged. Range has been reduced on both ends.  Given slight top-line out-performance this quarter, combined with the acquisitions of Blue Lithium and Right Media, the Q4 guidance seems light, which will trouble some people.  CFO Jorgenson also suggested some Q3 revenue gains were one-time (but then later reversed self and said "seasonal strength.")  We suspect the company issued intentionally conservative guidance.

Operating margin declined again (bad), especially in the U.S. U.S. op margin declined from 35% last year to 28% this year. Management is "not happy" about the margins, but blamed some of it on accelerated hiring in Q3.  It's time for some strategic cost cutting (read: layoffs). International operating margin rose a point Y/Y to 22%.

Free cash flow up modestly year over year (9%), but was goosed by decline in CAPEX to $150 million vs. about $250 million last year.  This growth is relatively weak, especially in light of the revenue growth.  On positive side, company is well-positioned for strong FCF growth in 2008.

Off-Balance Sheet assets (Alibaba, Yahoo Japan, Gmarket) valued at $9.2 billion end of quarter, or $6.50 a share. 

Conference call notes (uncorrected)...
Disclosure: I have a long-term position in Yahoo.

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