Yahoo! (Nasdaq: YHOO) reports its third-quarter operational results after the market closes tomorrow. Analysts are looking for EPS of 12 cents and revenue of $276.8 million. I expect little in the way of surprises because Yahoo! has good visibility into its future revenues (due to an average client contract length of around nine months). Barring some disastrous new information in tomorrow's earnings report, at a market value of $49.6 billion, Yahoo! -- the Rule Maker of Internet media -- looks like a prime candidate for some of the cash sitting in our account.
During the past quarter, almost exactly a quarter of Yahoo!'s market value has disappeared -- $18 billion vaporized. And year-to-date, over $80 billion of Yahoo!'s value has gone poof. (Where do those billions go, you ask? CNBC's Joe Kernen says they go to "money heaven -- with the angels." Call it theo-economics, I guess.) For both the Rule Maker Portfolio and myself as a shareholder, the continuous fall in the share price has been somewhat surprising considering the strong underlying business.
What I find most attractive about Yahoo! as an investment right now is the strong-business/weak-stock combination. You may exclaim, "It's the high valuation that's deflating the shares!" but I don't think that's necessarily the case. Our market is filled with companies whose stocks steadily move forward with their business success, even when valuations are already high. Have you punched up a quote on General Electric (NYSE: GE) lately? I'm a strong believer that ultimately the business and stock will move in the same direction. Our markets consistently reward companies that display operational excellence.
Surely Yahoo!'s business performance qualifies as top-notch. In the past 12 months, Yahoo! has grown revenues by 119% and free cash flow by 415%. What does that mean? Well, a year ago, Yahoo! earned 18.2 cents of free cash flow on each dollar of sales; now, that number has more than doubled to 44.2 cents -- that's the amount of pure profit on each dollar of sales.
All of that free cash flow rolls onto the balance sheet in the form of a constantly growing cash hoard -- now up to $1.6 billion -- and no debt. You'll also find lean working capital management with a Foolish Flow Ratio that's down to an all-time low of 0.34. That compares to a Flow of over 1.00 back in 1997.
Up and down the financials, you'll find nothing but a stellar model. There is literally not a single poor metric on the page.
That said, no business is entirely perfect. In Friday's Yahoo! Earnings Opinion Roundup, our own Tom Gardner criticized Yahoo! for not associating itself with a "brand family" of leaders the way other Rule Makers have done. He offered the example of the partnerships between Microsoft (Nasdaq: MSFT), Intel (Nasdaq: INTC), Dell (Nasdaq: DELL), and Cisco (Nasdaq: CSCO) that have allowed each of those companies to dominate a slice of the computer industry.
Yahoo! may not have those types of large-scale partners, but it has countless smaller partners from which Yahoo! aggregates content for its myriad Web services. One of the latest was Yahoo!'s deal with the NFL for rights to webcast live audio for 90% of this season's games.
All in all, Yahoo! continues to make headway in achieving its mission of being a one-stop shop on the Web. The key competitive advantage here is Yahoo!'s universal registration. Sign up once, and you get personalized access to everything that Yahoo! offers. Universal registration makes it simple for users to continuously try out Yahoo!'s ever-expanding array of personalized services. The more personalized services a user adopts, the more often they return to the site. It's a powerful model.
Two such services that are new for the quarter are designed to serve the small business market. First, Yahoo! Store users now have access to a conveniently integrated accounting solution from NetLedger. Second, small businesses in need of hosted server access can look to Yahoo! Servers.
Yahoo!'s broad popularity and convenience should make these offerings very attractive to small business owners. This is a very good thing, as small business is a huge and fast-growing market opportunity. According to a recent Upside Today article, there are more than 25 million small businesses in the U.S., and only half of those have Internet access.
During tomorrow's earnings conference call, I'll be interested to hear if the company says anything about early success with its various business services. To the extent that Yahoo! can expand its revenue streams beyond advertising, the company's investment potential becomes all the more favorable.
Next Monday, I'll offer a full analysis of Yahoo!'s third-quarter results.
In the meantime, I'm already prepared to recommend that the Rule Maker Port consider buying additional shares of Yahoo! For the remainder of this week, the other portfolio managers will chime in with their opinions. By the end of the week, we'll announce how we intend to allocate our current $2,100 of cash. We may end up buying more than one company. Stay tuned.
Note to reader: Interested investors should consider signing up for The Motley Fool's Biotechnology Investing Seminar Online, which starts October 16. The seminar offers 15 lessons over five weeks to help investors evaluate biotech companies. You can sign up until October 12 at midnight.
-- Matt Richey, TMF Verve on the discussion boards
