Will Yahoo ad business weather economic storm?

Some business sectors are definitely hurt by the current economic downturn, but major Internet sites dependent on advertising have been holding serious trouble at bay. Tuesday afternoon, investors should get a better idea whether the problems are hitting Yahoo.

The company is set to report results for its second quarter after stock market trading closes in the afternoon. Analysts surveyed by Thomson Reuters expect earnings per share of 11 cents on revenue of $1.37 billion.

But there is pessimism in the air. "Comments last week from Valueclick and Microsoft indicate the broader economic downturn is affecting online ads, particularly display, which could cause Yahoo's second-half guidance to suffer," UBS analyst Benjamin Schachter said in a report Monday.

Google, which three months ago all but sneered at macroeconomic concerns, was much more cautious last week while reporting its second-quarter earnings, and Google investors were spooked. But a careful listening to Google's remarks revealed more caution than actual evidence of negative effects.

Yahoo is more exposed to economic troubles, however. Google's cash cow is the text ads that appear next to search results, for which advertisers pay only when users click, whereas Yahoo is more dependent on the graphical display ads that are paid on the basis of how often they're shown.

Why does that make Yahoo more exposed? Because during a down economy, advertisers want a proven return on the dollars they invest, and it's easier to prove an ad is performing when you're only paying per click.

In a competitive curiosity, Yahoo plans to lean on Google's search ads in coming months. The two will become business allies through a deal under which Yahoo will show some Google search ads, though they're holding back implementation during a period of antitrust review.

Yahoo has said it expects up to $800 million in revenue from the first year of the deal by being able to show Google ads next to rarer searches where Yahoo's technology isn't as good. Google hasn't released a comparable number, but Cowen analyst Jim Friedland expects Google will get $100 million to $200 million in revenue in its first year of operation.

Judging by the yo-yoing of Yahoo shares in the last months, many investors had hoped for an all-out Microsoft acquisition or a lesser deal later under which Microsoft would have taken over Yahoo's search business. But in Friedland's analysis, the Google deal is better than the narrower search deal with Microsoft.

"We believe that the Google partnership is the best choice for Yahoo, barring an acquisition of the entire company. We estimate that a 'search-only' transaction with Microsoft has a net present value of $23 per share, compared with an NPV of $20 per share for the Yahoo-Google deal," he said. "However, the Microsoft deal precludes the purchase of the entire company, depends upon minimum traffic commitments and meaningful monetization improvements, and may be difficult to execute without causing a (further) implosion of morale and productivity."

Though economic uncertainty remains, Yahoo has dispensed at least partly with one major question mark, the push by investor Carl Icahn to replace Yahoo's board with his own slate of nine. Yahoo and Icahn settled their differences in a deal Monday that will give Icahn and two of his allies seats on the board and remove one existing Yahoo board member, Robert Kotick.

All the high-level discussions have probably taken a toll, though.

"We believe that the second quarter may be in line (with analyst expectations), but macro issues and distractions from ongoing Microsoft bid speculation may have taken a toll on the (reveneue) pipeline as well as forward guidance," Schacter said.