2016/07/27

Can Verizon Unlock Yahoo’s ‘Hidden Value’?

yahooYahoo, the online pioneer that defined how people searched the web, read digital content and sent email, is being sold to Verizon for $4.8 billion in cash, closing a chapter on one of Silicon Valley’s earliest innovators that failed to keep up with tech developments in the very internet it made reachable to millions of people.
The brainchild of two Stanford doctoral students, Yahoo’s two-decade run as an independent internet company reached a high in 2000, when its market value exceeded $100 billion during the dot-com boom. Yahoo even tried to buy Google in 2002, but was rebuffed. Years later, it would reject a buyout bid itself of $45 billion from Microsoft. Today, Yahoo is worth a much-diminished $36 billion. Compare that to Verizon’s market cap of $228 billion.
In a letter to employees, Yahoo CEO Marissa Mayer said the deal represents a “great outcome” for the company. Not only will it unlock shareholder value, but “it is also a great opportunity for Yahoo to build further distribution and accelerate our work in mobile, video, native advertising and social.” To grow, Yahoo hopes to leverage Verizon’s vast base of more than 100 million wireless users and industry-leading cellular, broadband and Internet TV networks.
Investors didn’t buy it, however, selling off Yahoo shares on the day the deal was announced. Verizon shares were slightly lower.
“Yahoo’s early story mirrored the story of the early internet. Yahoo got started in 1994 and quickly established itself as the go-to destination to find interesting content on the web. It had a phenomenal IPO and was valued at over $100 billion at its peak,” says Kartik Hosanagar, professor of operations, information and decisions at Wharton. “That valuation epitomized the belief that many shared about the internet’s long-term potential. Then the dot-com crash hit Yahoo like most other internet companies. Many companies went under, but Yahoo weathered that storm.”
He adds, “Unfortunately for Yahoo, it could not keep up with all the changes in digital media that happened post-2000, whether it was video (YouTube), social (Facebook) or mobile (WhatsApp, SnapChat).” According to Hosanagar, the issue was partly that Yahoo could never make up its mind on whether it was a technology company or a media company.
“While it claimed it was a media company and brought in several media executives, it was technology companies like YouTube and Facebook that were remaking digital media,” he notes.
“Yahoo’s early story mirrored the story of the early internet. Yahoo got started in 1994 and quickly established itself as the go-to destination to find interesting content on the web.”–Kartik Hosanagar
The ‘Peanut Butter’ Problem
Under Mayer, Yahoo significantly spiffed up its content offerings to attract eyeballs. It hired a cadre of prominent journalists, including former CBS News anchor Katie Couric and others from The New York Times, Time Inc., NBC News and Politico to report authoritatively on many topics. Yahoo alsolaunched about a dozen digital magazines revolving around food, fashion, technology, politics, travel, movies, DIY projects and parenting.
Still, Yahoo did not change its content business model to fit shifting trends. “Business models separate winners and losers in today’s economic landscape,” says Barry Libert, senior fellow at Wharton’s SEI Center for Advanced Studies in Management and CEO of OpenMatters, which specializes in business model science. “Although Yahoo was among the early search firms, it never evolved its business model or board to keep track with either Facebook or Google. It remained tied to its roots and although it innovated its products and markets, it stuck to its knitting.”
Libert notes that in the classic business book, In Search of Excellence, the authors made a case for why sticking to the tried and true was critical to success. “But that thesis was [35] years ago. Today, sticking to your knitting and existing board and strategies has as much value as a cotton loom,” he adds. “The answer to Yahoo’s future laid in inverting its business and mental models. It didn’t and as a result, Yahoo will join the ranks of Encyclopedia Britannica, Kodak and Blockbuster.”
Yahoo collapsed under its own weight. According to The Wall Street Journal, an internal Yahoo memo penned by an executive in 2006 called the “Peanut Butter Manifesto”pointed to the company’s lack of a “focused, cohesive vision.” He said Yahoo’s problem was that “we want to do everything and be everything — to everyone. We’ve known this for years, talk about it incessantly, but do nothing to fundamentally address it.” He called Yahoo’s strategy similar to spreading peanut butter — a thin layer of investment across everything it does and “focus on nothing in particular.”
Meanwhile, pressure from activist investors added to its troubles. “Yahoo’s recent woes are as much a story about activist investors as it is about missing the next big thing,” Hosanagar says. “Activist investors like Starboard interfered with management and made decisions focused on short-term shareholder gains rather than long-term viability of the business. When investors observed that Yahoo’s market cap was lower than the value of its Alibaba holdings, many swooped in hoping to break up the parts and extract value. This is what ultimately resulted in the sale of Yahoo’s core business to Verizon.”
Yahoo’s Next Chapter
Verizon is planning to combine Yahoo with AOL, which it purchased in 2015 for $4.4 billion, to build a digital content and advertising juggernaut and compete with the likes of Google and Facebook. AOL and Yahoo together boast more than 25 brands including Yahoo Sports, News, Finance and mail as well as AOL’s Huffington Post, TechCrunch, Engadget and AOL.com. Combined, they count more than one billion monthly active users, including 600 million monthly active mobile users. Verizon also plans to use its programming relationships with the NFL, NBA and others to boost its combined content offerings even more. On programmatic ad platforms, Yahoo’s BrightRoll will complement ONE by AOL.
“The answer to Yahoo’s future laid in inverting its business and mental models. It didn’t and as a result, Yahoo will join the ranks of Encyclopedia Britannica, Kodak and Blockbuster.”–Barry Libert
Yahoo will retain its stakes in Alibaba and Yahoo Japan and cash reserves. The company is changing its name once the deal closes in early 2017. Mayer plans to stay with the company at least through this next chapter of its life. The combined AOL and Yahoo will be headed by Marni Walden, president of Verizon’s product innovation and new businesses.
“Verizon’s acquisition of Yahoo serves two main purposes. One, any telecom platform (like Verizon) — and like Comcast a few years earlier — is always looking for synergistic content to distribute across its network,” says Eric Bradlow, Wharton marketing professor and department chair. “By acquiring Yahoo, Verizon acquires content that it can widely distribute. In addition, from a pure revenue side, Yahoo’s owning parts of Alibaba also provides Verizon a global opportunity for its network.”
In a conference call with analysts this week, Verizon CEO Lowell McAdam said the Yahoo acquisition “will make us an even stronger competitor in digital media.” The telecom company’s goal is to be a “significant” player in the digital video marketplace, which is currently dominated by Google and Facebook. “By acquiring Yahoo’s operating businesses, we are scaling up to be a major competitor in mobile media.” Verizon’s goal is to grow the global audience of its mobile media business to two billion users and book $20 billion in revenue by 2020.
To that end, McAdam said Verizon has been building its video assets so it can deliver content anywhere and on various platforms. These include offering large and small bundles of linear content through FiOS TV, improved customer experience using IP-based technology, over-the-top delivery of content, the purchase of AOL with its publishing and advertising technology and content, buying Millennial Media and launching its Go90 mobile video service, developing a global video distribution platform for other media companies to deliver digital content, and a Hearst partnership to invest in AwesomenessTV and others.
“For Verizon, the transaction makes the company much more important to the digital advertising industry,” wrote Pivotal Research analyst Brian Wieser in a recent report. Combining Verizon’s legacy digital ad inventory with those of AOL, Yahoo and others, the company would capture $8 billion to $9 billion of gross ad revenue and more than $4 billion to $5 billion of net ad revenue, he said. “This firmly entrenches Verizon as the number three seller of digital advertising behind Google and Facebook, and one of the largest across all media.”
A Long Way to Go
Still, the telecom company has a long way to go to catch up. Market research firm eMarketer said Yahoo’s share of net digital ad revenue worldwide fell to 1.5% in 2016 from 2.1% last year. That compares to 30.9% for Google and 12% for Facebook. Moreover, Verizon will face stiff competition from Google, Facebook and Twitter, which are all going aggressively into digital video, according to Bloomberg Intelligence. Nevertheless, the global video ad market holds much promise — it is expected to grow by 20% a year until 2018, according to ZenithOptimedia.
“This firmly entrenches Verizon as the number three seller of digital advertising behind Google and Facebook, and one of the largest across all media.”–Brian Wieser
Verizon’s main challenges are to return Yahoo’s core business to growth and reduce costs, Wieser said. Last week, Yahoo reported lackluster second-quarter 2016 results with net revenues down 19% year-over-year, EBITDA (earnings before interest, taxes, depreciation and amortization) falling by 34% and adjusted earnings per share diving by 43%, “suggesting rapidly shrinking fundamentals,” wrote Needham analyst Laura Martin in a recent research note. Meanwhile, Yahoo’s display revenue reflects 9% fewer ads sold and 15% lower prices charged.
Why would Verizon want a declining business? “Verizon, like all telecoms, fears that it might end up as a dumb pipe carrying all the content at commoditized rates,” Hosanagar says. “So Verizon has been transforming itself from being a typical telecom company to one that has genuine business ‘on top of the stack.’ Through acquisitions like AOL, Verizon has been adding an important content and digital advertising business. Yahoo fits well in that strategy. But can Verizon drive growth in Yahoo when multiple CEOs could not? Verizon hopes that all its mobile subscriber data will unlock the value hidden in Yahoo. Time will tell if that’s true.”
Verizon’s Content and Advertising Play
Gerald Faulhaber, Wharton emeritus professor of business economics and public policy, also questions how likely it is for Verizon to turn Yahoo and AOL into digital ad titans. “Verizon’s acquisition of Yahoo marks its second foray, after last year’s AOL purchase, into the online platform industry. Both purchases are of firms that are well past their prime, although each still has a sizeable presence in the online world,” he says. “It is unclear to me exactly what Verizon brings to these enterprises that will help them reverse their fortunes, nor is it clear exactly what Yahoo brings to Verizon’s core businesses.”
Faulhaber adds that “simply wanting to get into online advertising really isn’t enough; there must be value-added to the acquisitions on either or both sides, and Verizon has yet to convince us what that value-added is.” As for former AOL CEO Tim Armstrong, who Faulhaber said will effectively run the Yahoo/AOL enterprise, “he certainly has financial resources to support him, but again it is not clear how he will succeed where Marissa Mayer failed. Perhaps scale will bring new opportunities that neither AOL nor Yahoo could previously support, but I’m sure investors would like to hear what Verizon has in mind for this new enterprise.”
“An internet year is like a decade in a traditional business. It was not too long ago when Yahoo shareholders felt Microsoft’s offer of $44.6 billion for Yahoo undervalued the company.”–Kartik Hosanagar
A Eulogy for Yahoo
Hosanagar asks, “so what’s the lesson from Yahoo’s story? First, an internet year is like a decade in a traditional business. It was not too long ago when Yahoo shareholders felt Microsoft’s offer of $44.6 billion for Yahoo undervalued the company. Second, you can afford to have many loss leaders as long as you have one large, growing and highly profitable cash cow like Google has with search. For Yahoo, all the failed initiatives don’t matter as much as its inability to grow a core business.”
Hosanagar notes that “Google monetized search better than anyone else. Facebook monetized social better than anyone else. Yahoo could not convert all the eyeballs into a growing stream of cash. In fact, Yahoo made some good acquisitions over the years, but couldn’t convert them to growth engines. Along the way, Yahoo acquired Geocities and Tumblr for content, Inktomi and Overture for search, and BrightRoll and Right Media for advertising. But none of them could be converted into serious growth engines. Contrast that with Google’s acquisitions like YouTube and Android and, I suspect, over time … Nest.”
Its inability to focus on and substantially grow a core business has brought Yahoo to this point: a fading internet portal that will join former highfliers of its generation such as Excite, Infoseek, Lycos and AltaVista, all of which had blazed their own trails. “In the end, Yahoo creditably outlasted all of them,” Hosanagar says. “But all good things have to come to an end. RIP Yahoo.”

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