Don't buy Yahoo: There are better tech bargains around - Outside View by MoneyWeek

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Don't buy Yahoo: There are better tech bargains around
Sep 13, 2011

Anyone who's ever used the internet will have heard of Yahoo. It may have been eclipsed in fame by the likes of Facebook, but it's still one of the biggest web businesses on the planet.

Last Tuesday, the US firm fired its boss Carol Bartz - apparently via a phone call. That set off a real slanging match between Bartz and the board.

This latest news hasn't helped Yahoo shares, which have now fallen by almost 20% in two months. They're still two-thirds lower than in 2006.

That's more than enough to attract attention if you're a contrarian investor. But even if you're not, you could still make money in the sector.

Yahoo shares have collapsed over the past five years

With so much else going on in the financial markets (John Stepek summed up the main stories on Saturday), Yahoo's management problems may seem fairly low down on the investment pecking order.

But the firm's share price action could be of more interest than you might think. For one thing, you may already own stock in Yahoo.

That's because it's the 150th - give or take a place or two - biggest company in the S&P 500 index. The current market cap is more than $18bn. So anyone holding an S&P 500 tracker has a vested interest, however small, in how the stock performs.

And clearly something has gone very wrong with Yahoo. As we noted above, Yahoo shares now stand at just a third of their value of five and a half years ago.

Yahoo's troubles have been partly caused by tensions with its Chinese tech subsidiary Alibaba. This tie-up was arranged in August 2005, long before Bartz was in charge. But since she got the top job in January 2009, it's been a rollercoaster ride.

Despite staff cuts and various deals, the shares have made only a small net gain during her time in office. That compares with a near 50% lift in the S&P 500 in the same period.

Bartz "focused on bolstering Yahoo's online media and original reporting", says Claire Cain Miller in the New York Times. But "she neglected to develop the new social networking tools, video services or mobile apps that people now prefer to use".

In short, Yahoo "hit the wall and didn't continue to evolve as the rest of the market did", says Shar VanBoskirk at Forrester Research.

"It's been so long since Yahoo has done anything cool or interesting", says SplatF technology blogger Dan Frommer. "It has wasted so much talent and so many resources. It has squandered its early lead more times than I can count. Actually, it's pretty amazing Yahoo is still one of the biggest internet companies in the world - proof that even the worst-run big companies can still stay very big for a very long time".

Yet when a company's shares have underperformed as badly as Yahoo's have, often a management shake-up can be the catalyst for better days ahead. Will that now be the case with Yahoo?

Yahoo isn't a disaster - but it's not a buy either

The firm's balance sheet certainly gives an apparent good reason to be more bullish about the future. It's stuffed full of cash. At the end of June, Yahoo had a net $2.4bn in readies. So the company's new boss will have plenty of financial firepower for his or her next move.

But the problem that many observers identify is what Yahoo should be doing next. As Therese Poletti says on MarketWatch, it has "morphed into a media company that sells ads. It has straddled the line [between] being a media company and a tech firm, and is a mediocre hybrid of both. It still doesn't know where it's going".

"What advertisers want is an innovator to help them know the next best place to reach their customers", says VanBoskirk. "Yahoo's problem is they look like a legacy player that's not thinking about the next thing". In other words, you don't have to be a tech analyst to see that whoever takes over at the helm has some very tough decisions to make about the firm's future direction.

But has this uncertain outlook been fully factored into the stock price by now? Probably not. Despite the shares' poor recent performance, they still aren't exactly cheap. The current year forecast p/e is over 18, while shareholders don't get a dividend.

We're not saying the stock is a complete disaster. There have been rumours that Yahoo could be about to unload its stake in Alibaba - it still owns 39% - for as much as $11bn. Given that Yahoo's market cap is just $18bn, you can see this would be a huge boost to the firm's cash pile, and would almost certainly drive the shares higher in the short run.

Meanwhile, there are other stories floating around that might help to push the price up a bit. For example, Yahoo's co-founder Jerry Yang, who was pushed out as CEO before Carol Bartz was hired, is having a major spat with chairman Roy Bostock and is trying to take control again. But as he owns just 3.6% of the shares, he'd have to get some serious support from elsewhere to succeed.

So if you hold Yahoo stock, you may want to keep it for the moment to see if the sale materialises, or a buy-out occurs. But remember that these would be one-off events, and the price would probably fall back later. So if good news comes, then sell.

And if you don't already own Yahoo, I'd be wary of piling in now. A much better bet would be Google (Nasdaq: GOOG), which I wrote about in MoneyWeek magazine recently here. It's taken over from Yahoo as everyone's favourite internet search engine. It's growing fast - the current year p/e of 15 is forecast to drop to just over ten in two years' time. And with a net $35bn in the bank, it makes Yahoo look like a pauper.

This article is authored by MoneyWeek, the UKs best selling financial magazine. MoneyWeek offers intelligent, easy-to-read analysis of the financial news, with practical investment advice.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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