Yahoo! 2Q10 Preview. Incrementally More Positive

Yahoo is scheduled to report 2Q10 earnings on Tuesday July 20 after the close. Consensus is expecting net revenues of $1.16 billion and EPS of $0.14. Whisper numbers are for revenues of $1.17 billion and EPS of $0.15, i.e., the number to beat for the shares to rally. The shares trade at 5.1x 2010 EBITDA and 22x 2010 EPS vs. Google at 9.7x 2010 EBITDA and 17x 2010 EPS. The shares are attractive on an EBITDA basis but look expensive on a PE basis. However, with a few adjustments to EPS the PE looks reasonable. See a previous write-up where I walk through the calculation of Yahoo’s enterprise value.

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The shares have been stuck in a range due to several factors including macro sentiment, heightened competition in display particularly from an aggressive Google and Facebook, with the latter pressuring rates, lack of search share gains if you strip out the controversial queries, and uncertainty regarding the financial benefits of the Microsoft deal, although management have provided bullish estimates. In investors’ defense, Yahoo has a history of overpromising on financial targets and under-delivering. Remember the targets Jerry Yang provided to investors a few years back? For reference, the company guided for 18-24% operating margins by 2013 off a 7-10% revenue CAGR from 2010-2013, with 13-16% display CAGR, 3-6% search CAGR and 2-4% other revenue CAGR.

Bias is to the upside entering into 2Q earnings with one upgrade and a few bullish comments from several analysts. This is surprising in light of Google’s miss. In comparison, Yahoo does not have the outsized exposure to international relative to other Internet companies so FX is not likely to be a major drag on estimates. A significant share repurchase, which I suspect, should help Yahoo beat the consensus number. The company announced a $3 billion share repurchase authorization at the end of June. I have and continue to suggest that Yahoo lever up and shrink their equity.

Display advertising is likely to be the key driver this quarter and expect management to talk up the benefits of the World Cup. A prudent investor will strip out the benefits of the World Cup for both 2Q and 3Q.

Expect the company to once again talk up search as a key part of their long-term competitive strategy.

3Q guidance will be key as weak guidance has sunk the stock in the past. Consensus is at $1.17 billion and $0.16. A reaffirmation of their long-term guidance would be helpful to the stock as that guidance implied significant margin expansion driven by the Microsoft search deal. Don’t expect anything on the Asian assets short of that they continue to hold them and find them valuable. Recall at the analyst day, the CFO dialed back sale expectations of Yahoo! Japan stating that a sale would be dilutive and that the China assets are strategically important. They could take a page out of John Malone's book and spin those assets.

Expect comments pertaining to the progress of the search integration with Microsoft.

As far back as September 2009, in a write-up Stocks to Buy in a Cyclical Ad Recovery, I had suggested that investors stay on the sidelines with Yahoo. However, I am becoming incrementally more positive on the shares and will look for evidence from the 2Q report to decide whether we should go long the stock.

The company should be bulking up their presence in social media and online video. The company has a deep presence in mobile owing to device relationships a few years back but Andriod captures headlines.