Will Yahoo’s Merger With Verizon Pay Off?

Verizon paid $4.8 billion in cash for the struggling internet pioneer. How can the telecom make its purchase worthwhile?

yahoo

(Illustration by David Schwen)

Yahoo, the online pioneer that defined how people searched the web, read digital content and sent email, is being sold to Verizon for $4.8 billion in cash, closing a chapter on one of Silicon Valley’s earliest innovators that nonetheless failed to keep up with tech developments in the very internet it made reachable to millions of people.

The brainchild of two Stanford doctoral students, Yahoo had a two-decade run as an independent internet company that reached a high in 2000, when its market value exceeded $100 billion during the dot-com boom. Yahoo tried to buy Google in 2002 but was rebuffed. Years later, it would reject a buyout bid of $45 billion from Microsoft. Today, Yahoo is worth a much-diminished $36 billion. Compare that to Verizon’s market cap of $228 billion.

In a letter to employees, Yahoo CEO Marissa Mayer said the deal represents a “great outcome” for the company; not only will it unlock shareholder value, but “it is also a great opportunity for Yahoo to build further distribution and accelerate our work in mobile, video, native advertising and social.” Yahoo hopes to leverage Verizon’s vast base of more than 100 million wireless users and industry-leading cellular, broadband and internet TV networks.

Investors didn’t buy it, however, selling off Yahoo shares on the day the deal was announced. Verizon shares were slightly lower. “Yahoo’s early story mirrored the story of the early internet,” says Kartik Hosanagar, professor of operations, information and decisions at Wharton. “Yahoo got started in 1994 and quickly established itself as the go-to destination to find interesting content on the web. It had a phenomenal IPO and was valued at over $100 billion at its peak. That valuation epitomized the belief that many shared about the internet’s long-term potential. Then the dot-com crash hit Yahoo, as it did most other internet companies. Many went under, but Yahoo weathered that storm.”

He adds, “Unfortunately for Yahoo, it couldn’t keep up with all the changes in digital media that happened post-2000,” citing video (YouTube), social (Facebook) and mobile (WhatsApp, SnapChat). According to Hosanagar, the issue was partly that Yahoo could never make up its mind whether it was a tech company or a media company.

“While it claimed it was a media company and brought in several media executives, it was technology companies like YouTube and Facebook that were remaking digital media,” he notes.

 

The “Peanut Butter” Problem

Under Mayer, Yahoo significantly spiffed up its content offerings to attract eyeballs. It hired a cadre of prominent journalists, including former CBS News anchor Katie Couric and others from the New York Times, Time Inc. and Politico, to report authoritatively on many topics. Yahoo also launched about a dozen digital magazines focused on food, fashion, technology, politics, travel, movies and parenting.

Still, Yahoo didn’t change its content business model to fit shifting trends. “Business models separate winners and losers in today’s economic landscape,” says Barry Libert, senior fellow at Wharton’s SEI Center for Advanced Studies in Management and the CEO of OpenMatters, which specializes in business-model science. “Although Yahoo was among the early search firms, it never evolved its business model or board to keep track with either Facebook or Google. It remained tied to its roots, and although it innovated its products and markets, it stuck to its knitting.”

Libert notes that in the classic business book In Search of Excellence, the authors made a case for why sticking to the tried-and-true was critical to success. “But that thesis was [35] years ago. Today, sticking to existing strategies has as much value as a cotton loom,” he adds. “The answer to Yahoo’s future lay in inverting its business and mental models. It didn’t, and as a result, Yahoo will join the ranks of Encyclopedia Britannica, Kodak and Blockbuster.”

Yahoo collapsed under its own weight. According to the Wall Street Journal, an internal Yahoo memo penned by an executive in 2006, known as the “Peanut Butter Manifesto,” pointed to the company’s lack of a “focused, cohesive vision.” The exec wrote that Yahoo’s problem was that “we want to do everything and be everything—to everyone. We’ve known this for years, talk about it incessantly, but do nothing to fundamentally address it.” He called Yahoo’s strategy similar to spreading peanut butter—a thin layer of investment laid across everything the company did while it focused on “nothing in particular.”

Meanwhile, investor pressure added to the company’s troubles. “Yahoo’s recent woes are as much a story about activist investors as about missing the next big thing,” Hosanagar says. “Activist investors like Starboard interfered with management and made decisions focused on short-term shareholder gains rather than long-term viability of the business. When investors observed that Yahoo’s market cap was lower than the value of its Alibaba holdings, many swooped in, hoping to break up the parts and extract value. This is what ultimately resulted in the sale of Yahoo’s core business to Verizon.”

 

Yahoo’s Next Chapter

Verizon is planning to combine Yahoo with AOL, which it purchased in 2015 for $4.4 billion, to build a digital content and advertising juggernaut and compete with the likes of Google and Facebook. AOL and Yahoo together boast more than 25 brands, including Yahoo Sports, News, Finance and mail as well as AOL’s Huffington Post, TechCrunch, Engadget and AOL.com. Combined, they count more than one billion monthly active users, including 600 million monthly active mobile users. Verizon also plans to use its programming relationships with the NFL, NBA and others to boost its combined content offerings even more. On programmatic ad platforms, Yahoo’s BrightRoll will complement ONE by AOL.

Yahoo will retain its stakes in Alibaba and Yahoo Japan and cash reserves. The company is changing its name once the deal closes in early 2017. Mayer plans to stay with the company at least through this next chapter of its life. The combined AOL and Yahoo will be headed by Marni Walden, president of Verizon’s product innovation and new businesses.

“Verizon’s acquisition of Yahoo serves two main purposes. One, any telecom platform, like Verizon—and like Comcast a few years earlier—is always looking for synergistic content to distribute across its network,” says Eric Bradlow, Wharton marketing professor and department chair. “By acquiring Yahoo, Verizon acquires content that it can widely distribute. In addition, from a pure revenue side, Yahoo owning parts of Alibaba provides Verizon a global opportunity for its network.”

In a conference call with analysts in July, Verizon CEO Lowell McAdam said the Yahoo acquisition “will make us an even stronger competitor in digital media.” The telecom company’s goal is to be a “significant” player in the digital video marketplace, which is currently dominated by Google and Facebook. “By acquiring Yahoo’s operating businesses, we are scaling up to be a major competitor in mobile media,” McAdam said. Verizon’s goal is to grow the global audience of its mobile media business to two billion users and book $20 billion in revenue by 2020.

A Yahoo exec wrote in an internal memo that the company lacked a “focused, cohesive vision.”

To that end, McAdam said, Verizon has been building its video assets so it can deliver content anywhere and on various platforms. This strategy includes offering large and small bundles of linear content through FiOS TV, improved customer experience using IP-based technology, over-the-top delivery of content, the purchase of AOL with its publishing and advertising technology and content, buying Millennial Media and launching its Go90 mobile video service, developing a global video distribution platform for other media companies to deliver digital content, and a Hearst partnership to invest in AwesomenessTV and others.

“For Verizon, the transaction makes the company much more important to the digital advertising industry,” wrote Pivotal Research Group analyst Brian Wieser in a recent report. By combining Verizon’s legacy digital ad inventory with those of AOL, Yahoo and others, the company would capture $8 billion to $9 billion of gross ad revenue and $4 billion to $5 billion of net ad revenue, he noted. “This firmly entrenches Verizon as the number three seller of digital advertising behind Google and Facebook, and one of the largest across all media.”

 

A Long Way to Go

Still, the telecom company has a long way to go to catch up. Market research firm eMarketer said Yahoo’s share of net digital ad revenue worldwide fell to 1.5 percent in 2016 from 2.1 percent last year. That compares to 30.9 percent for Google and 12 percent for Facebook. Moreover, Verizon will face stiff competition from Google, Facebook and Twitter, which are all moving aggressively into digital video, according to Bloomberg Intelligence. Nevertheless, the global video ad market holds much promise—it’s expected to grow by 20 percent a year until 2018, according to ZenithOptimedia.

Verizon’s main challenges are to return Yahoo’s core business to growth and reduce costs, Wieser said. In July, Yahoo reported lackluster second-quarter 2016 results, with net revenues down 19 percent year-over-year and adjusted earnings per share diving by 43 percent, “suggesting rapidly shrinking fundamentals,” Needham analyst Laura Martin wrote in a recent research note.

Why would Verizon want a declining business? “Verizon, like all telecoms, fears that it might end up as a dumb pipe carrying all the content at commoditized rates,” Hosanagar says. “So Verizon has been transforming itself from a typical telecom company to one that has genuine business ‘on top of the stack.’ Through acquisitions like AOL, Verizon has been adding an important content and digital advertising business. Yahoo fits well in that strategy. But can Verizon drive growth in Yahoo when multiple CEOs couldn’t? Verizon hopes all its mobile subscriber data will unlock the value hidden in Yahoo.”

 

Verizon’s Content and Advertising Play

Gerald Faulhaber, Wharton emeritus professor of business economics and public policy, also questions how likely it is for Verizon to turn Yahoo and AOL into digital ad titans: “Verizon’s acquisition of Yahoo marks its second foray, after last year’s AOL purchase, into the online-platform industry. Both purchases are of firms that are well past their prime, although each still has a sizeable presence in the online world. It’s unclear to me exactly what Verizon brings to these enterprises that will help them reverse their fortunes, nor is it clear exactly what Yahoo brings to Verizon’s core businesses.”

Faulhaber adds that “simply wanting to get into online advertising really isn’t enough; there must be value added to the acquisitions on either or both sides, and Verizon has yet to convince us what that value added is.” As for former AOL CEO Tim Armstrong, who Faulhaber said will effectively run the Yahoo/AOL enterprise, “He certainly has financial resources to support him, but again, it’s not clear how he’ll succeed where Marissa Mayer failed. Perhaps scale will bring new opportunities that neither AOL nor Yahoo could previously support, but I’m sure investors would like to hear what Verizon has in mind for this new enterprise.”

 

A Eulogy for Yahoo

Hosanagar asks, “So what’s the lesson from Yahoo’s story? First, an internet year is like a decade in a traditional business. It wasn’t too long ago that Yahoo shareholders felt Microsoft’s offer of $44.6 billion for Yahoo undervalued the company. Second, you can afford to have many loss leaders as long as you have one large, growing and highly profitable cash cow, as Google has with search. For Yahoo, all the failed initiatives don’t matter as much as its inability to grow a core business.”

Hosanagar adds, “Google monetized search better than anyone else. Facebook monetized social better than anyone else. Yahoo couldn’t convert all the eyeballs into a growing stream of cash. Along the way, Yahoo acquired GeoCities and Tumblr for content, Inktomi and Overture for search, and BrightRoll and Right Media for advertising. But none of them could be converted into serious growth engines. Contrast that with Google’s acquisitions, like YouTube and Android and, I suspect, over time, Nest.”

Its inability to focus on and grow a core business has brought Yahoo to this point: a fading internet portal that will join former high-fliers of its generation such as Excite, Lycos and AltaVista, all of which blazed their own trails. “In the end, Yahoo outlasted all of them,” Hosanagar says. “But all good things have to come to an end. RIP, Yahoo.”


Update: The Impact of Yahoo’s Data Breach

In September, two months after Yahoo announced the Verizon deal, it broke the news that what it believes is “a state-sponsored actor” stole information relating to at least 500 million user accounts, or half its total monthly active user base of a billion-plus. A “full inquiry” into the massive data breach—which took place in late 2014—will decide the fate and revaluation of Verizon’s $4.8 billion bid to buy Yahoo’s operating assets, according to experts.

Hemant Bhargava, professor of technology management at University of California-Davis, and Northeastern University law professor Andrea Matwyshyn discussed the implications of the breach on the Verizon deal on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111.“With the extra negative reputation of the data breach, many users will defect,” said Bhargava. He estimated the liability cost to be between $25 and $200 per user. Verizon may insist that the Yahoo entities it is not buying foot that liability bill, he added. (Verizon is reportedly asking for a $1 billion discount.)

Some experts project a drop of between $100 million and $200 million on Verizon’s purchase price, Matwyshyn noted. Much of how Verizon will reassess its deal will depend on the breach’s impact on its larger strategy in video and digital media. Said Matwyshyn, “This kind of data valuation is partially art as well as science.”—Knowledge@Wharton

 

Published as “Mission: Unlock Yahoo’s “Hidden Value” ” in the Fall 2016 issue of Wharton Magazine.

 

 

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