Facebook Lurks Behind Yahoo! Earnings, As Portal Needs To Bet The Farm

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Yahoo! (NASDAQ: YHOO) revenue excluding traffic acquisition costs fell 6% in the first quarter to $1.13 billion. Net earnings dropped 28% to $223 million. Both numbers cheered Wall St. because they were better than expected. Yahoo!’s shares traded higher.

The question that several analysts asked was whether Yahoo!’s drop in sales was cyclical or not. That answer is “no”; the decline is permanent although it may not fall at a consistent rate.

Search advertising has been mentioned as the culprit behind the erosion of display advertising. Many security analysts say that is wrong. The main reason that the advertising revenue of Yahoo!, MSN, and AOL (NYSE: AOL) is threatened is the rise of Facebook’s audience. The social network now has 500 million members worldwide. It accounts for about a quarter of all display inventory in the US.

Facebook’s audience has been described as unruly as far as major marketers are concerned. It is difficult to target users who do not fall into easy categories driven by content-viewing habits. Facebook has begun to solve that problem in two ways. The first is to create better tools to target its “members.”  The other is to sell advertising at such low rates compared to the portals that the attractiveness of those rates is irresistible.

Yahoo! has reached a point where it has cut costs as much as is probably reasonable. That leaves it in a bind. It needs to create new products, social network-based ones, to hold its own. The success of these projects will rely on the ingenuity of Yahoo!’s engineers and marketers. To augment what the firm can do in-house,Yahoo!’s M&A staff has the challenge of using the company’s relatively small arsenal of cash and stock to buy into market which are attracting online advertising customers.

Yahoo! has reached a “bet the farm” stage. That may mean it will exchange a huge amount of its shares for control of a firm like Twitter or Groupon. The portal company does not have many significant options other than that. And, with the value of social network companies rising, Yahoo! needs to reach the window before it closes.

Douglas A. McIntyre