Yahoo Bets On A Glass Half-full

Yahoo Chief Executive Jerry Yang had some bold words to say while announcing the company's third-quarter financial results. The only problem is that they might have been a different set of words than disgruntled investors were expecting.

Though Yahoo announced a 10 percent layoff that will affect at least 1,430 employees, Yang and President Sue Decker also talked in optimistic terms about how the company is working to achieve a strong position when the advertising market recovers from the current economic troubles. It's smart to plan for the long-term, but right now, investors are fixated on Yahoo's short-term prospects.

"While the advertising market goes through a down cycle, we believe the Internet ad market will recover, with Yahoo positioned to take share," Yang said on a conference call to announce earnings. "Despite a tough environment, I remain very optimistic about Yahoo's future."

Investors were only modestly cheered by Yahoo's new position, though. In after-hours trading, a 7 percent increase the company's stock only erased the day's loss and left the stock under $13 per share. Compare that with the Microsoft acquisition offer, which when made public in February sent Yahoo's stock from $19.18 to near $29, and you'll see what Yahoo is up against.

Part of Yahoo's core problem today is that the online advertising market--in particular ads for autos, finance, real estate, and travel--is weakening. Another part is that Yahoo is more exposed to that trouble than its top rival, Google, whose stronger results afford it some of the breathing room Yahoo lacks.

Yahoo's net income has risen and fallen in recent quarters. (Credit: Yahoo)

Yahoo shows a combination of graphical "display" ads, used to promote advertisers' brand clout, and search ads that appear next to search results. Google makes the vast majority of its revenue from search ads, which are easier to tie to customer behavior like purchasing a specific product and which are paid for only when a person clicks on the ad. Because search-ad spending can therefore be tied closely to financial performance, spending can be justified and the ads are less vulnerable to an economic downturn.

Bank of America analyst Brian Pitz called the quarter "lackluster" in a report Tuesday. "The weakening economic environment continues to weigh on branded advertising," he said.

Cost cutting

Any company has two ways to improve profitability: increase revenue or decrease expenses. With advertisers' purse-strings tightening, the latter option rises to the fore.

Based on Yahoo's third-quarter expenses, the company spends money at a rate of about $3.9 billion a year. The layoff is central to a plan to cut that spending rate permanently by about $400 million.

That 10 percent expense cut is significant, to be sure, and Yang said in an internal memo about the layoffs that "having layoffs is very difficult, particularly in light of all we've experienced this year."

To refresh your memory, other difficult moments of 2008 included Yahoo cutting about 1,000 jobs already in January, trying to fend off Microsoft's unwelcome acquisition attempt, losing search market share to Google, and giving a seat on the board to activist investor Carl Icahn after an acrimonious struggle.

But Yang and his fellow executives are betting that this cut will be deep enough. Announcing the earlier layoffs in January, Yang declared, "We're making good progress executing on this strategy, and I'm confident we're heading in the right direction," but as it turned out, not fast enough. It's not pleasant being laid off, but it was easier for out-of-work Yahoo staff to find new jobs then than it is now.

Yang said the weakened spending environment triggered the current layoffs, and to be fair that environment that wasn't visible early this year. But there's no indication that the current economic woes will be short-lived, and Yang shied away from forecasting anything concrete.

"This is a pretty different environment than even four weeks ago," Yang said. "I don't think we have any visibility into '09."

Although the company reserved the option of more layoffs in 2009, those won't cut expenses or mollify investors today.

Here's the visibility investors have, though: Yahoo lowered its full-year revenue outlook from a range of $7.35 billion to $7.85 billion to a range of $7.175 billion to $7.375 billion.

Plan B

Layoffs, of course, aren't Yahoo's only answer to its plight, and some of its initiatives hold promise. Decker was eager to draw attention to Apt, the company's new system for letting advertisers deal with display ads, and to a move to a customizable Yahoo.com home page that's a centerpiece of the Yahoo Open Strategy. Ads on the home page are sold out in October, and there are only a few days available in November and December, "which is better than we expected," Decker said.

But one of the most promising possibilities is following in Google's footsteps with search ads. Growth in search queries was better than the 10 percent that ComScore estimated, Decker said, meaning that there are more opportunities to display ads. At the same time, Yahoo is improving the relevance of ads, a move that encourages users to click on them, and has improved revenue by instituting minimum bids for search advertisers in the United States, United Kingdom, and Japan.

One uncertainty, though, is what will happen with a Yahoo's search-ad deal with Google, implementation of which has been twice postponed as the companies grapple with antitrust regulators.

Yahoo hopes for $800 million in new revenue during the deal's first year by showing Google-supplied ads on for search results where Yahoo's technology currently can't, but it's not clear whether the deal will go into effect at the scale expected. Other wild cards include selling off decreasingly valuable Asian Internet properties and an acquisition of AOL that could come with a cash infusion from its corporate parent, Time Warner.

What remains to be seen is whether those possibilities and Tuesday's layoff announcement will actually be enough to set Yahoo on a new trajectory. The grim stock price indicates a number of investors appear would prefer the company Yahoo to pare back to some more profitable core, in effect hitting the reset button.

Overall, though, Yahoo is betting that smaller adjustments are appropriate, even though it raises the risk the company will end up muddling along through a series of not-bold-enough course corrections.

By Stephen Shankland