Excellent Bear Stearns Note on Yahoo

Bear Stearns Analysts Robert Peck, Alexia Quadrani, and Victor Anthony put out an excellent note on Yahoo and assigned it as a top pick. The note discusses several fundamental issues that Yahoo currently faces and is an excellent read for Yahoo investors. It also has a contrarian view on why Yahoo should not outsource search to Google. Unfortunately, the financial press focused on the one line in the note about Microsoft as a potential acquirer of Yahoo. That’s unfortunate because it took away from the overall meat of the note. Below is the summary.

Greed / Fear Pendulum. As we wrote in our July 16th note, we thought Yahoo! would use its 2Q call to reset expectations, given the new management team. We think that Jerry Yang’s “100 Day Review” was a major turning point for the company for several reasons: 1) it showed the company realized it needed to set a definitive strategic direction, 2) it acknowledged some past missteps as sunk costs and 3) it reset the NT expectations. While in the past investor sentiment around Panama had swung the pendulum too far to the optimistic (or greed) side, we think that the pendulum has now swung the other way towards the pessimistic (or fear) side.

More Conservative Model. Further, to be even more conservative, we have tweaked our 2008 and 2009 EBITDA to $2.1B and $2.4B from $2.2B and $2.5B, resp. This is more conservative than current Street ests of $2.3B and $2.6B, resp. While we acknowledge that Yahoo! still has plenty of challenges remaining and is clearly not out of the woods, we believe that Yahoo!’s shares represent an attractive risk/reward scenario for investors willing to wait for Yahoo!’s growth initiatives to deliver positive results.

Valuation Risk / Reward Appears Favorable. We are reiterating our Outperform rating on Yahoo!’s shares with a $30 08 target and establishing Yahoo! as our top pick. Yahoo! is trading at 10x 08 EBITDA or an EV/ EBITDA/ growth of 0.7x, which is at a discount to the traditional media cos. On a FCF / g basis, Yahoo! is trading at a discount to traditional media cos (1.5x v >2.0x) and is generating a generous FCF yield of ~5%.

Catalysts Over The Next 16 Months. We believe that there are several catalysts that could drive Yahoo!’s shares, including: 1) success from branding initiatives, 2) good results from Panama, 3) takeover / strategic partnership talks, 4) the Alibaba IPO, and 6) a material share repurchase.