Yahoo shortfall likely to radiate through Net

After the second straight quarter in which the leading Web portal warned of a major earnings shortfall, all eyes have returned to the health of the online advertising market and signs of ripple effects that could drown more dot-coms.

"If Yahoo is warning again, it's got to be pretty ugly," said Jim Nail, senior analyst for Forrester Research, who had predicted that the online advertising industry would grow between 20 percent and 25 percent this year. He now says those estimates could be off.

"Vast chunks of money have gone away. There's been a steep decline from the dot-coms and only a gradual increase in the money coming from traditional companies," he said. "This is an adjustment from a market that was fueled by the Internet bubble and venture capital cash to a market that's driven by serious marketers, who don't make multimillion-dollar decisions overnight."

Yahoo on Wednesday said in a statement that revenue for the first quarter will be revised to between $170 million and $180 million. The figures are a far cry from the $232 million in revenue and per-share profit of 5 cents that Wall Street analysts expected, according to First Call.

The company also said Tim Koogle will relinquish his role as chief executive.

Drops in online ad spending can be largely blamed on dot-com flameouts, such as eToys and Pets.com, whose dollars made up about 69 percent of the money spent on online advertising last year, according to Forrester. As that money started to vaporize, Internet companies dependent on ad dollars slowly began to choke. Dot-coms including Quokka Sports and Women.com have withered because of shrinking coffers, and even companies such as crime news site APBnews.com have burned out.

Although the softening advertising market will likely take down even more companies, analysts agreed that the survivors will reap the benefits of the shakeout.

"A likely outcome of this is that we'll see some more of these online media companies go away the way eToys and Pets.com did," Nail said. The silver lining is "there will be less inventory and it'll actually firm up prices for the survivors."

Added Laura Mitrovich, Internet market strategies program manager for The Yankee Group: "Online advertising is doing OK; it's not growing as quickly as it has in the past, but it doesn't mean that the industry is not healthy. It means that some healthy introspection is going on right now."

Internet ad spending softened in the third quarter, marking the first time Web ad sales dipped from quarter to quarter. For that period, sales reached $1.9 billion, down 6.5 percent from the previous period, according to the Internet Advertising Bureau (IAB). But in total, sales were up more than 63 percent compared with the third quarter of 1999.

"Nobody expected the dip because there have been such fantastic growth rates. The step back was devastating to people, but it doesn't mean the industry is dead," Mitrovich said.

Such a step back is a boon for Net advertisers, which are reaping the rewards of cheap deals and better service from online sellers, analysts say. In addition, ad sellers have begun to search for new ad formats to reignite interest in Net marketing, which has been bruised by perceptions that ad banners don't work.

Some industry pundits say that the growth of the last few years has been the exception, not the rule. Many revenue predictions and business models have been based on contrived economics, experts say, and the revised estimates merely reflect more realistic benchmarks.

"Yahoo is not doomed. The fact that it can't meet the previous stratospheric predictions is no surprise. Now it will operate with a more realistic market capitalization, business model and revenue stream," said one industry insider.

Many analysts, however, said they are worried that Yahoo's predicament is going to reverberate throughout the industry.

"This is going to fuel the hype even more that the online ad industry is in trouble," Mitrovich said. The perception in the industry is that many Internet companies depending on ad revenue can't make the model work, she said. But many of these companies have not been operating efficiently, running large organizations and entering into new areas too quickly.

"Internet-based companies are under tremendous pressure to turn profits on a life cycle that is much more compressed than we've ever seen," Mitrovich said.

"It's unrealistic to think that some magic can be applied to its business cycle just because it's distributed through a new channel--and suddenly it is profitable in a matter of months as opposed to years," she said.

Despite the dire warnings, online advertising is here to stay, financial analysts say.

"The advertising model can work because I don't see it any differently than TV and magazines," said Kathleen Heaney, a financial analyst at Blue Stone Capital.

"A lot of people are on the Internet, and more and more are coming on every month. Advertising (dollars) will go where the audience is," she said. "It's (not) a Yahoo problem, the industry is evolving into the next phase."

Forrester predicts that by 2003 traditional companies will spend roughly $23 billion in online advertising and digital marketing, compared with about $6.5 billion this year.

"The 30,000-foot view is that this is a short-term issue, which isn't to say that it's not ugly and that some companies won't survive before things get better," said Nail, who added that the first three months of the year is typically a slow time for advertising.