Microsoft (MSFT) Leverage: Yahoo! (YHOO) Could Lose Money In Q1

Microsoft (MSFT) CEO Steve Ballmer has yet again made a public comment about doing a search deal with Yahoo! (YHOO). Because Yahoo! still has a 20% market share in US search,  it probably assumes it can ignore Redmond or at least force Microsoft to put an extremely attractive deal on the table.

But, what if Yahoo! loses money this quarter on an operating income basis, which could certainly happen?

In the first quarter of 2008, Yahoo! had operating income of $121 million. For the period, Yahoo! had $1.82 billion in revenue and $1.063 billion in gross margin. Operating expenses were $941 million. With staff cuts, that could be closer to $900 million now.

Internet display CPMs a large online properties fell as much as 35% this quarter.  Barry Diller said that the figures at his sites were down 50% in January.

Yahoo!’s “fee” services, which were based on 17.4 million subscribers in the first quarter of last year, could stay flat at $245 million. The risk to Yahoo!’s revenue is in its display ad revenue. While its search sales may well hold up year-over-year, the erosion in display CPMs could certainly bring overall revenue down by 15%. The analyst consensus estimate is for a 10.1% drop.

A fifteen percent fall-off in revenue in the current quarter compared with the same quarter last year would bring the topline to $1.55 million and gross profits to about $900 million.

At that level, on an operating basis, Yahoo! might not do any better than break even. Any slip in sales beyond that, and the company loses money.

That would change the tenor of any conversations between Yahoo! and Microsoft.

Douglas A. McIntyre