Don’t Boo-Hoo for Bartz’s Ouster at Yahoo

Yahoo CEO Carol BartzYahoo (NASDAQ:YHOO) fired its CEO, Carol Bartz, on Tuesday. With The Wall Street Journal reporting that Yahoo is on the block, is now a good time to buy its shares?

Under Bartz’s tenure (she joined in January 2009), Yahoo’s stock price was flat and it lost market share. It closed at $12.91 on her last day in office and popped 6.3% after the announcement of her firing. According to eMarketer, Yahoo’s 2011 display advertising revenue is expected to fall 13.1% after a 14.4% decline in 2010. Meanwhile, Facebook is expected to gain market share.

By replacing Bartz with Yahoo’s CFO, Tim Morse, who had previous experience at GE Plastics, the board appears to be blundering twice in a row. That’s because Bartz had no social networking or Internet advertising experience when she came into the Yahoo job, and that lack of knowledge cost Yahoo market share.

To be fair, Morse is not a definite long-term replacement for Bartz. But unless he has turned himself into a social networking market leader since he started at Yahoo, he probably does not have the innovative talent needed to boost Yahoo’s market share. However, if his primary role is to sell Yahoo to the highest bidder, the board might not need to replace Morse.

But what if nobody wants to acquire Yahoo? Should you still buy the stock? Here are two reasons to consider it:

  • Great earnings reports. Yahoo has been able beat analysts’ expectations consistently and has in all of its past five earnings reports.
  • Fair valuation. Yahoo’s price/earnings-to-growth ratio of 1.20 (where a PEG of 1.0 is considered fairly priced) means its stock price is reasonable. It currently has a P/E of 14.7, and its earnings per share are expected to grow 12.2% to $0.84 in 2012.

Two reasons against:

  • Under-earning its cost of capital. Yahoo is earning less than its cost of capital — and it’s making no progress. How so? It’s producing no EVA momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first half of 2011, Yahoo’s EVA momentum was 0%, based on first six months’ annualized 2010 revenue of $4.9 billion, and EVA that improved slightly from first six months’ 2010 annualized -$808 million to first six months’ 2011 annualized -$793 million, using a 10% weighted average cost of capital.
  • Declining sales but rising profits and cash-rich balance sheet. Yahoo sales have decreased while its profits rose. Its revenue fell at a 0.4% annual rate, from $6.4 billion (2006) to $6.3 billion (2010), while its net income has increased at a 12.4% rate, from $751 million (2006) to $1.2 billion (2010) — yielding a wide 19% net profit margin. Its debt has plunged while its cash has risen. Specifically, its long-term debt has fallen at a 34% annual rate, from $750 million (2006) to $142 million (2010), and its cash rose at a 2.8% annual rate, from $2.6 million (2006) to $2.9 billion (2010).

Bartz did a pretty good job of cutting Yahoo’s costs, but she outsourced innovation by forming partnerships — such as one with Microsoft (NASDAQ:MSFT), in the wake of a failed $33-per-share buyout.

Microsoft might be able to acquire the now more profitable Yahoo for, say, $20 per share — much less than it offered three years ago. Meanwhile, if Yahoo can hire a new CEO who can innovate — namely come up with new services that boost Yahoo’s revenue growth — then the stock could rise on its own.

If you think either or both of these outcomes is possible, it might make sense to invest in Yahoo shares.

Peter Cohan has no financial interest in the securities mentioned.

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