Yahoo’s $1.1 Billion Mistake

Yahoo ($YHOO) is buying Tumblr for $1.1 billion which, in my opinion, is a big mistake. I’ve long been a critic of Yahoo, or more specifically, Yahoo’s valuation. It’s a fine company but it’s not an especially fast-growing company.

I think Yahoo is basically similar to a newspaper and it should be valued the same way. For many years, I said that Yahoo should be valued around $15 per share, and I was usually right in that the stock failed to perform.

The advent of Marissa Mayer, however, has changed that and the stock has jumped over the last few months to $27 per share. Yahoo is still over-priced but not as egregiously as before.

The good news for Yahoo is they got a pile of cash from selling off their stake in Alibaba. This brings us to the “Bladder Theory” of corporate finance — oftentimes too much cash is not a good thing. Management feels they have to do SOMETHING BIG. Too much cash over-inflates the role of management, and they feel they have to do something dramatic. As I’ve often said, there’s nothing wrong with a special dividend.

Yahoo clearly feels the need to stay hip and cool so buying Tumblr seems like an easy choice. From the New York Times:

The blogging site has been trying to create new ad efforts like interactive campaigns, rather than using standard clickable ads, with mixed success. It has set a revenue goal of $100 million for this year; the company reported only $13 million for the first quarter and reported $13 million for 2012.

Despite its ranking as the 24th most viewed Web site on the Internet, according to Quantcast, Tumblr has yet to translate that into success on mobile devices, something Yahoo needs.

Tumblr also bears a fair amount of unsavory content that may unsettle advertisers. Pornography represents a fraction of content on the site, but not a trivial amount for a site with 100 million blogs.

The search for profits isn’t unique to Tumblr, as free apps and services struggle to wring money from their users. Instagram famously generated no money when Facebook bought it.

A good indicator of a bad merger is when it’s done out of fear, and that’s what this is. Ideally, a merger should appear to be an obvious extension of both parties’ business. Yahoo is paying more than 10 times revenue for a company that might not hit its revenue target. I don’t see the need for that.

At Fortune, John Saroff has a better idea:

Instead of Tumblr, I propose that Yahoo focus its cash not on bulk of pageviews, but on acquisitions and R&D that erect barriers to entry (Buffett’s famous moat) around its already robust display business. Those likely take the form of deep investments in the product and engineering corps and strategic acquisitions of adtech businesses. Those maneuvers will be less sexy, but they have the potential to reinvigorate Yahoo for the next 20 years. It is hard to see how, with all of the strategic risks inherent in the deal, acquiring Tumblr builds the moat for Yahoo that I believe it needs

Posted by on May 20th, 2013 at 11:12 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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