The Company

The News

A Bear Stearns analyst turned bullish on

Yahoo

Robert Peck on Tuesday published a report reiterating his Outperform rating on the stock, which has slumped 11% year to date, calling Yahoo "our top pick for the next 12 to 16 months."

Shares hit a 52-week low of $22.27 last week as investors questioned whether Yahoo can overcome the significant challenges it faces from competitors like Google. Neither takeover speculation nor the return of co-founder Jerry Yang to the helm in mid-June has rallied the stock. Yang replaced Terry Semel, who served as chief executive for six years.

Yet Yang wasted little time in getting to work, and that's starting to pay dividends. The company on July 16 reported quarterly earnings of 11 cents a share, in line with Wall Street estimates. On a conference call to discuss those results, Yang said Yahoo needed a whirlwind review of its operations, which he pledged to complete within 100 days.

"There will be no sacred cows and we need to move quickly," he told analysts and investors on July 17. Peck on Tuesday referenced Yang's midsummer announcement as a major turning point.

"One, it showed the company realized it needed to set a definitive strategic direction; Two, it acknowledged some past missteps as sunk costs and; Three, it reset the [near-term] expectations," Peck wrote.

On Aug. 30, Jackson Securities analyst Brian Bolan raised his rating on the stock to Hold from Sell, reversing a May downgrade made as rumors of a buyout by Microsoft swirled around the embattled Semel, then Yahoo's CEO.

"While we are still waiting to see what Yang has in store for Yahoo, we note that the valuation has become more reasonable and our Sell rating is no longer warranted," Bolan wrote.

The Analysis

There's not a lot of news here, but there is an acknowledgement that Yahoo hasn't rolled over and given up against Google, and that on balance there are still reasons to see the stock as a potential bargain.

"One of the points made was that things are not great there, but when you talk about the stock, a lot of the risks and challenges they have are already factored into the price," says Martin Pyykkonen, an analyst at Global Crown Capital. "This is not a story that is going to fundamentally change and go right to the positive."

Lower expectations, then, could yield some significant benefits, particularly in the impact of Yahoo's recently unveiled Panama ad-targeting technology, which is now in its first full quarter of global use.

Peter Zollman, publisher of Classified Intelligence, a newsletter and consulting group, says there's room for Yahoo to surpass conventional wisdom when most of it is negative.

"They've had a lot of advertising issues and I think a lot of what they've been doing has not clicked as well with the market as Google has," he says. "What they've been doing just hasn't shown the same growth and hasn't generated the same excitement."

Or worse, it generated negative sentiment that contributed to Yahoo's precipitous since the beginning of 2006. Over the 20-month period the stock shed nearly half its value.

That helped push the number of short-sellers up over the summer, though some shorts bailed out between July 10, when 70.8 million shares were held short, through Aug. 10, when 62.3 million shares were held short, representing, about 5.2% of Yahoo's public float. Peck's assessment that Yahoo had more room to go up than down likely influenced a few of those shorts to unwind their positions, contributing to an intraday high of $24.50 a share, a 7.8% climb.

"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 toward the pessimistic (or fear) side," Bear's Peck wrote. "We think the Street has largely discounted many of the positives we see for Yahoo! over the coming quarters, such as: addressing the branded demand on premium inventory; partnering with eBay for incremental advertising and payment revenues, development of behavior ads with Smart Ads, improving non-premium monetization with Right Media acquisition, and continuing to rollout its new search monetization (Panama) globally."

At the same time, the subprime mortgage crunch and the spreading consequences to the larger financial-services industry will take a bite out of Yahoo and its competitors as advertising drops off. Sandeep Aggarwal, at Oppenheimer & Co., estimates that Yahoo got about 12% of its ad revenue from financial services advertisers, and another 4% from mortgage ads. Google revenue was at about 10% and 3%, respectively, he estimated in a Monday note.

The Bottom Line

Wishing for good things doesn't make them happen, and Yahoo still has much to do, but the flashes of optimism from Wall Street provide a little valuable perspective.

"Is it a lost cause? I certainly don't think so," says Zollman. "Do they have their work cut out for them? Yes, but they've got good people. Lots of dot-coms get hammered, I think, unfairly, because expectations are so unbelievably high."

One reasonable expectation investors can have for Yahoo is that it will settle its leadership issues definitively. Pyykkonen expects that President Susan Decker, whose hands-on performance gets praise from the Street, "will be running the company, just not with the CEO title." Senior personnel turnover is still an issue. Gregory Coleman, executive vice president of global sales, was replaced by Hilary Schneider, executive vice president of Yahoo's local markets and commerce division, according to reports on Monday.

Yahoo can go either way at this point in its reorganization, and Jackson Securities' Bolan thinks it will do both. He expects "a precipitous drop in operating income in the [current] quarter, and there may be headline risk associated with this," he wrote.

But he added that most of the downside is already factored into the current stock price, and that it's sitting at a "low water level."

For investors who don't mind getting their feet wet for a while, this may be a time to back the turnaround and buy, according to Pyykkonen. "It should be a nice return for a relatively patient investor, for a buy-and-hold type," he says.