Yahoo's Secret Weapon for Growth

Yahoo! (NASDAQ: YHOO  ) is one of the best performing Nasdaq stocks this year: Its price has more than doubled. Clearly, Marissa Mayer has done a great job restoring investor confidence and trust. Moreover, top-line performance has improved, and considering traffic metrics are quite healthy, organic revenue growth could materialize soon. But what exactly is causing the amazing stock price increase?

YHOO Chart

Source: YCharts

Yahoo! is a great tech fund
Unlike Google (NASDAQ: GOOGL  )  or Facebook  (NASDAQ: FB  ) , Yahoo!'s revenue isn't growing yet. The good news is that investors are not long in Yahoo! shares because of its fundamentals, or the future prospects of its search engine. Yahoo!'s main attractions are the stakes it owns in some very promising companies.

First, Yahoo! is very active at acquiring promising start-ups. Some of the businesses it acquired last year include microblogging platform Tumblr for $1.1 billion, Qwiki, an iPhone app that lets users create short movies, for $40 million -$50 million, and Admovate, a mobile ad targeting firm, for an undisclosed amount. 

These companies share some similarities. All of these ventures have a focus on Internet and mobile sectors. Although they are at an early stage in monetization, they have been able to create massive traffic with few resources. Some of these businesses may be overvalued, but overall Yahoo! seems to be doing a great work at identifying hidden gems.

Yahoo! also has a 24% stake in Alibaba, the king of Chinese online retailers, which some analysts estimate to be worth up to $120 billion, due to the high-transaction volumes its Taobao and Tmall.com services handle. Taobao allows its users to engage in bargaining, and has become extremely popular in mainland China. It reported $3 billion in sales on a single day, November 11 -- the Chinese equivalent of Valentine's Day.

The last pearl in Yahoo!'s portfolio is its 35% stake in Yahoo! Japan, which grew its revenue by 19% in the latest quarter, and has roughly the same market capitalization as its American counterpart.

Strong exposure to China's largest online marketplace, investments in hidden gems, and a large stake at Yahoo! Japan explain why Yahoo!'s shares keep rising despite the absence of organic growth. 

Will Yahoo!'s fundamentals ever improve?
Yahoo!'s assets are so attractive that some investors may forget about its search engine -- 38% of revenue -- and advertising business.

Tte acquisition and integration of several apps and services, improvements in search result pages, and a new mobile focus and team have been able to moderate the decreasing trend in sales. However, these efforts have not been enough to cause growth.

The good news is that if we consider all services under the Yahoo! brand, from Flickr to Yahoo! Finance, then Yahoo! is actually getting more traffic than Google. In August, analytics company comScore released a report showing 197 million people visited Yahoo!'s sites in July, 5 million more than visitors to Google's search engine and the rest of Google's sites.

Therefore, the huge difference in revenue between these two giants is not a matter of traffic. Most Yahoo! services are simply not as well-monetized as Google's search page results. As Yahoo! introduces new monetization approaches to some of its new services and increases the number of mobile ads, I expect revenue to start showing some growth.

Source: Huffington Post, comScore

Notice Facebook's innovative Graph Search feature, which gives personalized answers to natural language queries using a user's friends network, could become a disruptive force in the search engine arena. In order to obtain early feedback, this feature has only been released partially. However, Facebook may be preparing an aggressive launch. It plans to integrate the new feature with Instragram photos, and develop a future mobile interface of its search engine.

However, the potential success of Graph Search will not be a huge problem for Yahoo!, due to its diversified portfolio and medium exposure to the search engine arena. Google, on the other hand, gets 80% of its revenue from this market, and is highly exposed to any innovation conducted by competitors.

Keep in mind Yahoo! isn't the only tech company worried about top-line growth. Google itself has seen its growth rate slow down, from almost a 60% revenue growth rate in 2007, to less than 20% this year. Furthermore, more than a third of its 2012 growth was due to Motorola Mobility. After an amazing growth phase, the company may be reaching maturity, and will need to rely more on acquisitions to keep up with high expectations.

On the other hand, Facebook is at an early stage. Its ability to turn traffic into revenue is set to increase. With 41% of its advertising revenue coming from mobile, the social network is expected to grow enormously in the next decade, due to its mobile business and huge user base. The company may have not figured out monetization yet. However, its exposure to the mobile space and ability to offer customized ads has significant potential.

What a Fool believes
Over the past 10 years, Yahoo! has built an excellent portfolio of IT investments. Apart from owning more than 20 promising start-ups, it has exposure to the huge Chinese online retail space and it owns 35% of Yahoo! Japan, one of the biggest IT companies in Japan. Finally, management has kept traffic high and as mobile as possible, preparing the road for further monetization.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 04, 2013, at 11:00 PM, aza400 wrote:

    I heart Marissa. We are witnessing a true turn around story.

  • Report this Comment On October 05, 2013, at 1:49 AM, TCL wrote:

    i think what is happening is pretty awesome at Yahoo. I use a lot of their properties on a daily basis. Yahoo Finance is second to none. Yahoo sports is great. I use their email services. And many of their other services. Facebook on the other hand, i basically stopped using as I feel too exploited by their mining of my personal information so I have to go there and change all my personal data but these days none of my friends use it much anymore and I only look at photos now.

    wouldn't surprise me that Facebook or an Apple would go out and buy Yahoo. Heck, even Priceline can go out and buy Yahoo these days.

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