Yahoo sees its glass half full

Yahoo chief executive Jerry Yang had some bold words to say while announcing the company's third-quarter financial results on Tuesday. However, they may have been a different set of words to those which disgruntled investors were expecting.

Although Yahoo announced a layoff of 10 percent of its workforce 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 may be wise to plan for the long-term but, at the moment, 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. In after-hours trading, a seven percent increase the company's stock only erased the day's loss and left the stock under $13 (£7.90) per share. Compare that with Microsoft's acquisition offer, which, when made public in February, sent Yahoo's stock from $19.18 to nearly $29.

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 of the problem is that Yahoo is more exposed to that trouble than its top rival, Google, whose stronger results afford it some of the breathing room that Yahoo lacks.

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 behaviour, 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 "lacklustre" in a report on Tuesday. "The weakening economic environment continues to weigh on branded advertising," he said.

Cutting costs
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 $3.9bn a year. The layoffs are central to a plan to cut that spending rate permanently by about $400m.

That 10 percent expense cut is significant, 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".

Other difficult moments in 2008 included Yahoo cutting about 1,000 jobs 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.

Yang said the weakened spending environment triggered the current layoffs. Admittedly, 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 2009."

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

Investors can, however, see that Yahoo has lowered its full-year revenue outlook from a range of $7.35bn to $7.85bn to a range of $7.175bn to $7.375bn.

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 a move to a customisable Yahoo.com homepage that's a centerpiece of the Yahoo Open Strategy. Ads on the homepage 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.

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 US, UK and Japan.

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

Yahoo hopes for $800m in new revenue during the deal's first year, 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, Yahoo is betting that smaller adjustments are appropriate, even though it raises the risk that the company will end up muddling along through a series of insufficiently bold course corrections.