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Beware of all enterprises that require new clothes.-- Thoreau

Stocks To Short?
Frodar's Short

Frodar is a regular AOL member, and also a participant in our AOL Shorting Stocks folder. Frodar has an MBA from Stanford and has had success with shorting Netscape (Nasdaq: NSCP) and Einstein/Noah Bagel (Nasdaq: EBNX). Lest we think Frodar is perfect, he admits being short Florida Panthers (Nasdaq: PUCK) at $19.75. The stock currently trades at $26.

Yahoo! Inc.(Nasdaq: YHOO)
3400 Central Expwy., Ste. 201
Phone: 408-731-3300
Message Board
Price - $32 1/8

With a billion-dollar capitalization and $9.5 million in revenues last quarter, Yahoo's valuation is clearly rich. In fact, its market cap is more than half of industry titan Netscape's. Traditional stock analysis indicates the share price is lunacy, but because this is the Internet, all bets are off. Those who are buying the stock believe in the most blindly optimistic future for this company, and may well be ignoring the challenges Yahoo will face.

Yahoo's business is selling advertising space on its web pages. It attracts viewers by providing news and information. The fundamental problem with this business is that competition will be intense, and there is already an abundance of inventory. Similar sites are aggressively advertising (on television, no less!). ESPN, CNN, MTV, and push services like Point Cast are also hoping to find Internet gold. All of these companies have a perishable inventory, the size of which greatly exceeds foreseeable demand. With virtually no switching costs for advertisers, the price of this commodity will be driven down by competition.

But competition isn't the only threat Yahoo will face. Netscape has already gotten $30 million in revenue guarantees for allowing the Netscape Guide by Yahoo. To the extent that Yahoo is successful, Netscape can charge whatever it wants to continue this arrangement. The words "Netscape Guide by Excite" describe Netscape's negotiating position in a nutshell.

Yahoo bulls may say that as the Internet grows, they'll have more inventory. But Yahoo can't sell all they've got, and revenues only grew by $1 million quarter to quarter. Bulls may say that Yahoo has a great brand. But buyers don't care about brand. They are buying commodity clicks. Bulls may point out all the investment Yahoo is making in developing city specific cites, and services like Yahooligans. But those are expensive to develop and maintain, and still provide those commodity clicks. Readers of Yahoo's most recent 10-Q know that Yahoo is planning to increase spending significantly. Will the revenues really materialize to justify the cost?

For Yahoo to be worth a billion dollars, they will have to prove that they can sell tens of millions of dollars in ad space each quarter, that their operations can be profitable, and that their brand can insulate them from competition. This is unlikely to happen for the reasons stated above.

The future I see is investor disenchantment as costs grow too quickly, revenues grow too slowly, and profits remain elusive. Any one of a dozen scenarios could kill this stock, including a consumer switch to push technology, a price war, advertisers preferring more targeted web sites, or Netscape raising its fees.

Yahoo is currently trading in the low 30s. In my opinion, if everything goes well for Yahoo, it is worth less than half that. Yahoo trades at more than 30 times annualized revenues of last quarter, and should trade at a revenue multiple of less than 10. I plan to close or reevaluate my short position when the stock hits 15.

Next Article: TMF News' Short

* This column represents the opinion of one Fool and in no way should be taken as the opinion of either the Motley Fool, Inc., the company in question or representative of anyone or anything else other than that specific Fool's thoughts.

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