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Investors brace for possible Yahoo revenue slump

It's déjà vu all over again for the portal as it faces a sliding stock price and predictions of a coming online advertising drought.

It's déjà vu all over again for Yahoo as it faces a sliding stock price and predictions of a coming online advertising drought.

Shares in the Internet bellwether plunged $12.19, or 9 percent, to $122. 06 at the 1 p.m. PT close of regular trading, following a negative analyst report that cited slowing online marketing spending from battered dot-coms. The report echoes warnings that preceded Yahoo's second-quarter earnings report last month, which led the stock to seesaw as investor concerns gave way to euphoria when the company wound up posting better-than-expected earnings.

A subsequent month of cautious optimism was reinforced by new reports that showed an increased interest in online advertising from traditional companies such as Coca-Cola. This trend could more than offset any decline in spending by failing Internet start-ups, which have so far spent the most on ads.

But with today's report the skeptics are gaining ground, and investors are once again faced with the million-dollar question: How badly will the dot-com shakeout hurt online ad sellers such as Yahoo?

A growing list of Wall Street analysts thinks things will get worse before they get better. Even though the sector dodged some key earnings disappointments last quarter, many analysts say the revenue slowdown was merely delayed. They predict it will break through in the coming months with the financial results of major Web portals and legions of lesser ad sellers.

"The second quarter didn't really show the pullback," said Derek Brown, an analyst with WR Hambrecht. "The numbers weren't particularly reflective of actual financial problems at many e-tailers and Internet-based companies. The financial crisis didn't really happen until second quarter."

Size and diversity are key factors to weathering the storm, analysts agree. Most believe that companies in the "top tier"--the sweet spot reserved for the 10 or 20 most-visited Web sites--stand the greatest chance of escaping a serious mauling.

For example, giant Internet service provider America Online is considered well insulated from an advertising falloff because it makes the lion's share of its revenues from subscriptions.

Yahoo's size alone counts in its favor. But some analysts are concerned that it hasn't broadened its base of advertisers sufficiently beyond foundering dot-coms.

Lehman Brothers' Holly Becker today became the latest analyst to predict that the Internet bellwether would feel the effects of the dot-com slowdown. Because most of Yahoo's revenues are derived from advertising, the trimming of marketing budgets and work forces among dot-com start-ups could directly affect the company, she said.

Of Yahoo's top 200 advertisers, 61 percent are dot-com companies, and only 23 percent are traditional advertisers, according to the analyst's report, which cited July figures.

"Our contacts suggest that the environment continues to worsen, and we believe it is only a matter of time before we see the impact on Yahoo's results," Becker wrote in a note to investors. She has a "neutral" rating on Yahoo.

A Yahoo representative said that analysts are unduly concerned.

"We have met with analysts that have requested meetings, as we typically do during the quarter. At this juncture, we see no material change to our past statements about our business," a Yahoo representative said. "As we've identified in discussing the June quarter, we are not immune to the changes in the dot-com world, and we are working a little harder in this quarter than in past ones given the tightness in dot-com advertising budgets."

In fact, market research predicts that online advertising spending will boom in the coming years. Reports from market research companies including Jupiter Communications, Veronis Suhler and the Internet Advertising Bureau have shown that online ad spending will continue to grow.

Some of these reports also point to a shift in who is advertising online. They indicate that despite the dot-com budget cuts, more traditional companies are developing online advertising programs in their marketing budgets. Traditional advertisers are getting pickier about these programs and are demanding clearer results from their ad campaigns.

Safra Ratschy, a senior analyst with US Bancorp Piper Jaffray, said traditional advertisers such as Procter & Gamble, Miller Brewing and General Motors are beginning to take up the slack ceded by dot-coms. He said the effect could be seen as early as the fourth quarter.

Analysts don't dismiss those ad-spending studies, but some say any silver lining must be carefully assessed on a case-by-case basis.

"On one hand, it's fair to say we are seeing massive adoption of online advertising," said WR Hambrecht's Brown. "At the same time, we need to look at how that adoption is affecting each company on a one-by-one basis and whether the impact on the company is ahead of, below or in line with what's currently expected for them on the street."

Jordan Rohann, an analyst with Wit SoundView, said he is not worried about Yahoo for the long term, although he said its growth may be tempered in the coming months. He predicts 80 percent revenue growth for the third quarter from the same period last year.

Michael Parekh, an analyst at Goldman Sachs, acknowledged growing online ad pressures in a report released yesterday, but he said Yahoo appears to be well protected.

"Despite the expectation of some near-term weakness in dot-com-related advertising spending, we believe that Yahoo remains very well positioned," he wrote, citing the company's "large and increasing share of mainstream advertisers."

The current business environment for Internet companies is "tougher for second-tier portals," Parekh wrote.

As for the immediate future, Piper Jaffray's Ratschy said weakness in Yahoo's third quarter has been expected by some; he called today's run on the stock "a self-fulfilling prophecy."

"People have been worried about the stock, and the fears make it a reality," he said.

Ratschy said a shakeout is coming, but that the outlook is bright for the top players in various categories. For portals, that means AOL and Yahoo, he said.

Wit SoundView's Rohann said investors should look for weakness among second- and third-tier sites, as well as for online advertising networks such as DoubleClick, Engage Technologies and 24/7 Media.

The third quarter "will be a more difficult quarter for businesses that are highly dependent on bulk banner advertising," he said.

WR Hambrecht's Brown agreed, warning that the much-anticipated dot-com shakeout has barely begun to take hold.

"There's clearly weakness in the online ad market," he said. "This may affect second- and third-tier companies pretty dramatically. We are also concerned that real effect will not be felt for one or two more quarters."