2HRS2GO: Independence the only choice for Yahoo

COMMENTARY--It has been the most frequently asked question about Yahoo for the last couple of years.

Even before the deal that created AOL-Time Warner (NYSE: AOL), people were wondering when Yahoo (Nasdaq: YHOO) would find a Big Traditional partner. The idea was first floated when Disney bought Infoseek. It returned to discussion tables when Excite joined @Home. More Yahoo merger rumors emerged when USA Networks (Nasdaq: USAI) tried to merge with Lycos.

At this point, there's nothing left to create buzz. All the other portals have joined someone.

That doesn't mean it's the best move for Yahoo.

Generally speaking, other Web content portals have merged with ISPs (Excite@Home, Terra Lycos) or old world media (AOL Time Warner, Walt Disney Internet Group). Either way, the idea is to generate more traffic and increase the time users spend on the Web site, which leads to higher advertising rates and commerce opportunities. In some cases, it's also a way to survive--let your new parent absorb the losses and figure out a way to profitability.

It's hard to justify any of those reasons in Yahoo's case.

Yahoo already gets the most pure Web traffic of anyone, although AOL also has its proprietary network. Would joining with a large partner markedly increase Yahoo's rate of traffic growth? Probably not. If anything, it will create the perception that Yahoo is narrowing its audience. By not affiliating with any communications service provider, Yahoo can appeal to everyone.

A large media partner wouldn't bring anything new. Cross-promotional activities? Yahoo doesn't need them; nearly everyone online knows about Yahoo. More content? Yahoo already features plenty of top-notch material from wire services, large news organizations, entertainment centers, sports and almost anything else you care to name. The company's commerce initiatives haven't exactly taken the world by storm, but neither has anyone else's.

Yahoo certainly doesn't need a large backer to survive. Despite the depressed world of online advertising, Yahoo still has profits and plenty of cash. It's a more viable operation than any of the traditional media ventures, such as the soon-to-be-gone Disney Internet Group.

In fact, none of the previous portal mergers have been unqualified successes so far. Disney Internet Group is about to shut down. Terra Lycos resulted in the departure of the two men chiefly responsible for engineering it. Excite@Home seems to exist mainly as a headache for AT&T (NYSE: T). AOL-Time Warner might be moderately successful, but it's too soon to tell.

Viewed against those precedents, Yahoo's decision to stay independent clearly has been the right one for its operations. Unfortunately, people remain merger-obsessed for the worst of all reasons: the stock.

Yahoo's share price decline is no secret. It exemplifies the dot-com crash. You can safely conclude that the company will never regain the triple-digit price-to-earnings ratios it enjoyed at its peak.

That's market reality, but it's not a reason to do a deal.

And in the unlikely event that Yahoo directors wanted a merger, now would be a bad time anyway. At roughly $25, the stock price is too low to make a substantial acquisition without incurring ruinous dilution; and it's too high--Yahoo's market cap is nearly $14 billion--to present an appealing buyout candidate. From a merger point of view, Yahoo currently occupies the worst of both worlds.

To justify a long-term buy of Yahoo at this point, you have to believe the stock will rise on the company's own merits. That's not likely to happen as long as the current advertising climate exists, especially for Yahoo. The stock has fallen more than 85 percent from its 52-week high, yet still trades at 68 times First Call's estimated 2001 earnings.

That multiple falls if you value Yahoo purely on operations and excluded taxes, interest and non-cash items, but even on that basis, Yahoo remains the most expensive member of its group.

"Yahoo! trades at approximately three times that of most offline media companies," writes Robertson Stephens' Lowell Singer, who isn't even the most bearish of Yahoo analysts. "While we acknowledge that Yahoo's growth potential exceeds that of these more mature companies, which should translate into a higher multiple, we believe that this valuation disparity suggests that there is more downside risk to Yahoo's stock."

Yahoo would have to lose a lot more ground on Wall Street before the stock becomes an appealing buy-and-hold scenario in today's climate. And if the stock price goes on another precipitous decline, a merger might not seem so unrealistic after all. 22GO>