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JACKSON SECURITIES, LLC

Research for the Prudent Investor

Date 7/14/06 Yahoo! (YHOO): Initiating


Current Price $32.23
Coverage with a “BUY”
52WK HI $43.66
52WK LO $28.60
recommendation
EPS (TTM) $1.24 • Industry: Internet Services
Shares Outstanding 1.4B • YHOO: NASDAQ; $32.23 Buy initiated 7/14/06: $32.23
Market Cap. $47B • 12-month price target: $37.00 Target: $37.00
Dividend Yield NA
Price/Earnings (TTM) 26.8X
Price/Sales (TTM) 8.2X
EV/Revenue (TTM) 7.9X
EV/EBITDA (TTM) 25X
EBITDA (TTM) $1.77B

Brian Bolan
Research Analyst Company Description
Technology Yahoo! is an internet search and technology platform for all media that
has established itself as the leader in its growing market. Free downloads
Jackson Securities, LLC
300 S. Wacker Dr., Suite 2450 of applications, tools and other media based products have helped to
Chicago, IL 60606 broaden the idea of Yahoo! from more than just a search engine to a
destination site and platform for new media delivery.
Ph: (312) 253-0578
Fax: (312) 986-0560
Valuation and Recommendation:
bbolan@jacksonsecurities.com
There is certainly room to grow for Yahoo! as the search market and
numerous other media outlets increasingly move their budgets online.
That being said, we note that Yahoo! trails Google in several categories
and faces other risks from companies like Microsoft and others. We
recommend investors BUY shares of Yahoo!
Jackson Securities, LLC seeks to do business with companies covered in its
research reports. As a result, investors should be aware that the firm may have a
conflict of interest that could affect the objectivity of this report. Investors should
consider this report as only a single factor in making their investment decisions.
Please also refer to the important disclosures found on page numbers 16 and 17.
Analyst Certification is found on page number 16.
Yahoo! (YHOO)

Introduction to Yahoo............................................3

Key Products………………………………………....3

Industry Outlook……………………………………..5

Management Discussion……………………….7

Earnings Analysis………………………………8

Growing by Acquisitions………………………9

Click Fraud……………………………………….10

Risks……………………………………………….11

Valuation………………………………………….12

Thesis……………………………………………..14

Appendices

Earnings Model………………………………….15

JACKSON Brian Bolan 2


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

Introduction to Yahoo!

Yet Another Hierarchical Officious Oracle is the acronym for what


is now known as Yahoo!. Yahoo! was first made available in
1994, and the company has been growing ever since. In 1996 the
company had 49 employees and went public.

Despite being a clear leader in the industry, Yahoo! has been


consistently dogged in the search space. From claims that Alta
Vista had a faster search engine at the time of the Yahoo! IPO to
current competition with Google, this internet bellwether has been
plagued by contention.

Split adjusted yearly perfomance of Yahoo!


Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05
Ending Price 0.7083 4.3281 29.6172 108.1719 15.0313 8.87 8.175 22.515 37.68 39.18
Year Performance 511% 584% 265% -86% -41% -8% 175% 67% 4%

Key Products

As content poured onto the Internet, it was apparent that search


engines would be needed to organize and rank the content based on
a simple text search. This keyword search is the basis for the
search engine that locates web pages based on the words that a user
types in. This is also the mechanism that has propelled billions of
advertising dollars to the internet in the form of banner ads,
sponsored links and graphic splash pages among others. It wasn’t
until Yahoo! purchased Overture in 2003 that the company finally
became a principal in the search business as it sought to monetize
what was a nascent business.

Yahoo! has always been about attracting a large number of users


and the company quickly moved to be more than just the search
engine to become a media platform. Media offerings include, but
are not limited to, Yahoo! Email (233M users), Yahoo! Messenger
(79 M users), Yahoo! Music Experience and numerous Yahoo!
properties that have been visited by more than 471 million people.

JACKSON Brian Bolan 3


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

The company has embraced recent renaissance of social


networking with its purchases of Flickr and social tagging concern
Del.icio.us. We expect Yahoo! to continue to acquire businesses
that are growing and early in their development stage.

The Search Business model


The first business model in the search business employed an idea
of cost per thousand or CPM. This is a standard term in the
advertising business and basically means that for every thousand
views a buyer pays X amount. While this number is hard to track
for mediums such as newspapers or billboards, it can be
specifically tracked and placed in high value areas (targeted) for
the advertiser. The model then moved to a cost per click (CPC),
where the advertiser would only pay for each click on the
advertisement as opposed to the paying for just a viewing of the
ad. This fostered the idea of a click through rate (CTR) a term that
is wildly used today. For example, if an advertisement was run as
a result of a keyword search 1000 times, and clicked on 24 times, it
would have a click through rate of 2.4%.

As a leader in the monetization of the search tool, Yahoo! has been


able to adapt with the competition. Recently, Yahoo’s chief
competitor in the space released a new product that will likely be
the foundation for a new shift in the advertising model. While this
new product is being subsidized in hopes to get more advertisers
and consumers on the platform, we know that Yahoo! has had
similar capabilities for some time. Yahoo! launched its Wallet
application in 1999 and it is fully integrated with its system. This
application will be a critical integration when the CPA (Cost Per
Action) model begins to take hold with advertisers.

When we spoke to representatives at Yahoo!, they noted that while


there are rumblings of a shift in the model, advertisers still are
quite happy with the CPM model and the CPC model as well. The
CPM model is one that advertisers are quite familiar with and
while the other models offer better tracking and ROI equations, the
end game is still the same. Company management also pointed out
that there was similar buzz surrounding a model known as Click to
Call, which enabled a VoIP based toll free line in a banner ad but
has yet to overtake the traditional models.

JACKSON Brian Bolan 4


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

Building a Lasting Platform of Technology and Content

Building tools and applications for a web based audience launched


Yahoo from being a search engine to the most frequently used site
on the planet. This is no small feat, considering the number of
competitors available in almost every language. The early formula
for success was delivering a dependable search service and
aggregating content that users were looking for.

Convinced that mass traffic was the way to make the most on the
Internet, Yahoo focused on keeping visitors on its site, providing
original content and thus delivering more advertisements to
consumers. With popular properties like Yahoo! Finance, Yahoo!
Maps and Yahoo! HotJobs the company has been ranked number
one in terms of the number of visitors per month for the last
several years.

Yahoo! has also focused on the individual user and has provided
fee services that attract and keep users. One the of the biggest
successes in this arena has been the Yahoo! Fantasy Football
league. Fantasy Football has exploded in popularity over the last
few years and we expect this trend to continue. We note that
Fantasy Football is a major driver in the third quarter of the year
and is a major portion of the number of paying customers in that
quarter.

Other areas where users pay for services can found throughout the
entire Yahoo! network. In the most recent quarter, Yahoo! had
13.3M fee paying customers, up more than 49% from the same
period one year ago. We believe that this is a key metric and is
one we will follow closely.

Industry Outlook

The search industry is dominated by three main players, Google,


Yahoo! and Microsoft. This is not to say they are the only search
engines available for use or investment, but they are clearly head
and shoulders above the competition.

JACKSON Brian Bolan 5


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

The combination of the other search engines account for less than
20% of the remaining market. Some of the more popular names in
that group include Ask.com and Infospace.com. Others that are
lesser known but just as interesting include names like IceRocket
and Snap. It should be noted that emerging technologies
developed by these smaller players in the industry are capable of
shifting the status of the current business model.

Most data for market share calculations comes from independent


third parties. While there are some differences in the numbers, the
general consensus is that about 50% of all the searches made in
May 2006 were done on Google. Yahoo held 22% and Microsoft
Search Market Share
captured around 11% of the
market. Neither Yahoo! or
60.0% Google have officially
48.2% 48.5% 49.0% 50.0% 49.1% endorsed any of the raw
50.0%
numbers that the market share
40.0% calculations are based upon.
GOOG In the most recent quarter,
30.0% YHOO
22.2% 22.0% 22.0% 22.0% 22.9% Yahoo! made a stand on its
MSFT
20.0% conference call and noted that
11.0% 10.7% 11.0% 11.0% 10.6% the market share numbers and
10.0%
the total search queries have
0.0% begun to trend away (and in a
January February March April May meaningful way) from their
internal logs. This means that
Source: NetRatings.com
the market share number for Yahoo! is likely to be growing instead
of being held constant as the independent numbers suggest.

Looking Ahead

Its quite obvious that the whole market is engaged in redesigning


its search products for a mobile market. Hundreds of millions of
dollars worth of R&D budgets are being spent on generating the
best mobile search for your PDA or 3G phone. One of the best
examples of this is the relationships that Research In Motion
(RIMM) has with many of the search and Internet companies.
Yahoo! was among the first to recognize the power of the
developing mobile platform. The company synchronized its
Yahoo Mail and popular Instant Message application to work in a

JACKSON Brian Bolan 6


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

seamless fashion with the BlackBerry platform in an attempt to


further solidify its foothold in the mobile market. Similar deals
were made with Motorola and Nokia, two of the largest mobile
device makers.

Making your product more than just mobile ready, but mobile easy
will be a key component of future success. We have seen that
Yahoo! is intent on doing this and believe that they will continue to
be a leader in the mobile search and application platform. One
example of this leadership is evidenced by the launch of Yahoo!
Go platform at CES in January of this year. The Go platform gets
Yahoo! email, calendar, IM and other tools and applications onto
mobile devices at the hardware stage. The platform is also a
springboard for relationships with the carriers and to date, Yahoo!
has agreements with over 50 carriers world wide. We expect
Yahoo! to continue to be a leader in the mobile device category.

Management Discussion

Summary

Yahoo has had a number of key people to help drive their


leadership position as a destination well into the future. Focusing
on entertainment and its delivery to mobile platforms is key for
this group, and expertise in these areas is essential.

Terry S. Semel is the chairman and chief executive officer of


Yahoo! Inc, a leading global Internet company. Semel is focused
on providing the strategy and vision that will allow Yahoo! to
attain its goal to be Internet's leading global consumer and business
services company. A globally-respected media and entertainment
executive, Semel was named Yahoo!'s chairman and CEO in May
2001. Prior to Yahoo!, Semel spent 24 years with Warner Bros.

Jerry Yang co-created the Yahoo! Internet navigational guide in


April 1994 with David Filo and co-founded Yahoo! Inc. in April
1995. Mr. Yang, a leading force in the media industry, has been
instrumental in building Yahoo! into the world's most highly
trafficked Web site and one of the Internet's most recognized
brands.

JACKSON Brian Bolan 7


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

Yahoo! has been able to hire some top tier talent, and recent
additions of note include Lloyd Braun. Braun was most recently
chairman of ABC Entertainment Television Group, a division of
The Walt Disney Company, a position he held from January 2002
until April 2004. Prior to that, he served as co-chairman of the
division from July 1999. In this position, Braun had responsibility
for all creative, programming and business areas of the division,
which encompassed Touchstone Television and ABC
Entertainment. Braun is head of Media and Entertainment.

Another notable hire was that of Christian Lindholm from Nokia as


VP of Global Mobile Product. Lindholm is uniquely qualified as a
leader in the expanding mobile arena and will drive shareholder
value in the segment.

Earnings Analysis

Our earnings model shows that we have confidence that Yahoo!


can generate both higher revenues and earnings over the rest of the
calendar year.

Internet companies are faced with a seasonality that follows the


rest of the general market. Quarters one and four tend to be the
strongest, while quarters two and three are weaker with quarter two
being the among the weakest.

As reported:

When Yahoo! reports earnings, they break out revenue into two
separate categories, Marketing Services revenue and Fees
revenue. The larger of the two numbers is the Marketing services,
which is comprised of the search engine revenue and other services
performed by Yahoo!. Fees revenue, albeit quite a bit smaller
than the marketing services revenue, is still a meaningful segment
of the business and one that serves as a hedge against the
possibility of a revolt by advertisers against the web. Fees
revenues consists of memberships fees and the revenue generated
from customers for services like Fantasy Football.

JACKSON Brian Bolan 8


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

The marketing services line item brings us to the idea that is TAC.
TAC is simply traffic acquisition costs, but that is where the
simplicity ends. Examples of this are found throughout the web
where a search box is positioned on a site. It will often allow for a
search of that specific site or a search of the world wide web. In
the event a user searches the web, and clicks on an ad, Yahoo!
would pay a royalty of sorts to the web site that helped facilitate
the search that ended up in a click on an advertisement. The exact
amount of the royalty is a closely guarded secret and is subject to
volatility based on performance (the number of searches and
subsequent click throughs).

TAC, as a financial metric should be subtracted from any gross


revenue calculation to provide a higher quality number for the top
line. It should also be noted that TAC should only be looked at in
relation to Marketing Services revenues as it is not a factor in the
Fees revenue line item.

Growing by Acquisitions

Yahoo has grown over the years and has done so mostly via
acquisition. Notable large acquisitions in the past include Mark
Cuban’s Broadcast.com (streaming media), Overture (payment
solution for advertising) and HotJobs (Job Search). Yahoo! has
shifted its focus to the smaller developing companies in the
internet such as Flickr (photo hosting) and Del.icio.us (social
tagging).

Selected Yahoo! Acquisitions


Target D ate Announced Purchase Price C omment
Broadcast.com 4/ 1/ 1999 $4.65B We have Yahoo! to thank for Mark C uban
O verture 7/ 14/ 2003 $1.37B Yahoo! becomes a principal in the search market
H otJobs.com 12/ 12/ 2001 $338M A distant third in the job search market

Flickr 3/ 20/ 2005 <$50M C alled "photo-blogging", ties in well with D el.icio.us
D el.icio.us D ecember-05 <$30M Social tagging that continues to grow in popularity
D ialPad 6/ 14/ 2005 NA Allows for VO IP calls to be placed from Messanger

JACKSON Brian Bolan 9


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

We expect that Yahoo will continue to be an acquisitive company


and continue to grow shareholder value even as they primarily use
stock for these transactions.

Of late, we have been hearing rumors of a possible merger between


Microsoft and Yahoo in order to better complete with Google. On
first glance, this idea seems to be a bit drastic as there likely to be
many more evolutions in the search industry. Upon deeper
analysis of the concept of a combined company, we believe that it
would be a formidable competitor to GOOG and result in
significant advantages for Yahoo! shareholders.

Click Fraud

Click fraud is a topic that the media seems to be pushing more and
more these days, without a clear end / culprit in sight. Click fraud
is a process of setting up content (possibly a blog or some other
site) and then selling ad space on the site. Recent reports state the
number of fraudulent clicks could be as high as 14.6% of all clicks.
The actual number is likely to be a bit less than that, as it was on
the high end of the range that we uncovered.

The fraud part of the equation comes into play when an advertiser
sees that they are paying for many more clicks than normal and
those clicks are conversely not translating into sales. Yahoo has
stated that they take the problem very seriously and do investigate
all claims that any clicks are fraudulent. Yahoo! has also offered
and paid refunds to advertisers that feel that they have been victims
of click fraud.

A comparison of lawsuits concerning click fraud that both Google


and Yahoo! recently settled, shows that the Yahoo! settlement
amount was much less than that of their major competitor. By not
billing advertisers up front on clicks, Yahoo! believes that they
have as strong of a filtering system as any available in the market.

We note that click fraud is an industry wide problem, and not


unique to Yahoo!. It may also be completely destroyed if the
potential model shift to cost per action gains traction. But much
the same way spam evolved into phishing and phishing evolved
into click fraud, there will always be a less scrupulous means of
defrauding advertisers and the public alike.

JACKSON Brian Bolan 10


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

Risks

Any investment in a technology company such as Yahoo! is bound


to carry some risk and there is no exception to that rule. We
believe that there are some inherent risks that all technology
companies face and they include, but are not limited to, the loss of
high caliber human capital and inability to adapt to changes in the
business environment.

Yahoo! also faces other significant risks like increasing


competition. Microsoft and Google are their main competitors and
they are both well funded and well run companies that move
quickly and adapt to changes in the market. In the coming
quarters, we expect to see a new and improved search product from
Microsoft and Google has already moved to shift the model to a
CPA structure.

A risk that investors should be aware of is that should the


company’s search tool begin to lose relevance or not deliver the
best results, customers will likely move to another search engine.
This would have an adverse affect on revenue and earnings.

One risk that we see is the possibility that in a few more quarters or
possibly years, advertisers in general will be upset seeing all the
revenue that Yahoo! is generating from them. This might instigate
a potential shift in the business model or possibly an allegiance
among advertisers as they try to limit the amount that the search
engines make. This is certainly a reach at this point, and
something we will go into more thoroughly in future reports, but it
is still something that is in the back of our minds.

The age of the stealth Internet play has mostly come and gone, but
in the event that another company builds a better, faster and bigger
mouse trap (search product), a negative impact would be felt on
Yahoo!’s share price.

Finally, the Company has stated that it expects its growth rate to
slow and its margins to possibly shrink. This can be construed as

JACKSON Brian Bolan 11


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

just boilerplate risks added to a 10K or 10Q, but the main idea is
that the company cannot continue to post triple digit revenue
growth. Many will point to the law of large numbers or the idea
that the company has reached a plateau on the new consumer front,
and we would agree with both of those ideas.

Valuation

We believe the best way to measure the value of shares of Yahoo!


is to look at earnings. Earnings are the main factor one should
consider when evaluating any stock. The stocks with the higher
growth in earnings deserve the higher multiple.

We can see from the table that Yahoo! has a high forward multiple
within this particular set of peers. We note that a direct match for
Yahoo! is not really available as they participate in several
different businesses. This peer group is focused on the search
aspect of the business, but it should be noted that Yahoo! is also
very strong in media and media delivery.

In a direct comparison to Google, we note that Yahoo! carries a


higher forward multiple but lower trailing multiple. A measure of
cash flow, Google has nearly twice the amount of EBITDA as
Yahoo, but also carries a much higher risk as evidenced in the
higher price to sales. An even more conservative measure, the
book value, shows that Google is trading at an aggressive 12x its
hard asset value while Yahoo! is trading at less than half of that at
5.6x

JACKSON Brian Bolan 12


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

Looking back at the range for the multiples for Yahoo!, we see the
market generously afforded a multiple of 355x turning the end of
the dot com bubble wash out. We do not believe that such a
multiple will come back to the stock anytime soon. We also note
that the low end of the range was also found at the time of the
imploding bubble, and feel that 28x for a growing company such
as Yahoo is very cheap.

We believe that the current multiple is on the low side and one
positive earnings surprise should bring the multiple up closer to the
historical mean. We believe that a 70x multiple for this years
earnings is achievable and equates to a target price of $37 per
share.

Going forward, the key for Yahoo! will be to grow earnings to


allow the multiple to expand.

Source: Bloomberg

JACKSON Brian Bolan 13


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

Thesis

As a media platform, YHOO is a compelling option, but the search


segment is still tops in the minds of investors. The intense
competition with Google and Microsoft will eventually lead to
lower margins in the business and with Google growing share at its
current pace there is likely to be little in the way of positive news
for Yahoo!.

Yahoo! will likely continue to work on its platform as a media


delivery of the new age. By expanding the availability of existing
content from other channels and generating original content
Yahoo! will likely become a medium in and of itself. We view this
as a long term goal and something that the company has already
taken large steps to achieve.

Current valuations put Yahoo! at a discount to its chief competitor


in the search space, Google. We believe that due to the company’s
diversification into a wider array of media delivery and fees from
services that Yahoo! provides investors with more downside
protection than Google. A multiple of 70x’s this years earnings is
not only within the historical range, but at the low end and thus
very achievable in conjunction with earnings growth. We
recommend that investors purchase shares of Yahoo! at the current
levels.

JACKSON Brian Bolan 14


SECURITIES, Research Analyst – Technology
LLC
Yahoo! (YHOO)

JACKSON Brian Bolan 15


SECURITIES, Research Analyst – Technology
LLC
Analyst Certification
I, Brian Bolan, hereby certify that the views expressed in this research report accurately reflect my personal views
about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or
indirectly, related to the specific recommendations or views expressed in this research report. I may be
compensated in part based on the overall profitability of Jackson Securities, LLC, which includes earnings from
investment banking and all other aspects of the firm’s business.

Important Disclosures
Disclosure of Conflicts of interest:
Neither Jackson Securities nor any of its publishing analysts or their immediate family members has a position in the
securities described herein.

Compensation:
• The research analyst has not received compensation based upon investment banking revenues or from the
subject company in the last 12 months.
• Jackson Securities has not in the last 12 months managed or co-managed a public offering of securities,
received compensation for investment banking services from the subject company or any compensation for
products or services.
• Jackson Securities does not expect to receive or intend to seek investment banking compensation from the
subject company in the next 3 months.

Position as Officer or Director:


Neither the research analyst nor a member of his/her immediate household is an officer or director with the
company/companies mentioned in this report.

Market Making:
Jackson Securities does not make a market in this stock
Explanation of Ratings:
Buy - Expected 12-month absolute performance of +10% or higher
than the market price at which time the rating was issued.
Hold - Expected 12-month absolute performance of +5% to –5% from
the price at the time the rating was issued.
Sell - Expected 12-month absolute performance of –10% or lower than
the market price at which time the rating was issued.

Distribution of Ratings:
Jackson Securities, LLC has a distribution of ratings among its coverage universe as follows:
Buys – 65.52% (38 of 58 active recommendations)
Holds – 31.03% (18 of 58 active recommendations)
Sells – 3.45% (2 of 58 active recommendations)

Jackson Securities has provided investment banking services within the previous 12 months with the following
percentage of the companies they have rated:

Buys – 2.64% (1 of 38 active recommendations)


Holds – 0% (0 of 17 active recommendations)
Sells – 0% (0 of 2 active recommendations)

Risks: General economic conditions, economic slowdown/recession, adverse industry news.

Disclaimer: This communication is neither an offer to sell nor a solicitation of an offer to buy any securities
mentioned herein. This material should not be construed as an offer to sell or the solicitation of an offer to buy any
securities mentioned herein in any jurisdiction where such an offer or solicitation would be illegal. We are not
soliciting any action based on this material. It is for general information only, and it does not constitute a personal
recommendation or take into consideration the particular investment objectives, financial condition or financial needs
of any clients. Before acting on any advise or recommendation in this research report, clients should consider seek
professional advice. Past performance is not a guide to future performance. Future returns are not guaranteed, and
a loss of original capital may occur.
The information contained herein has been obtained from sources that we believe to be reliable, but we do not
guarantee its accuracy or completeness. Any opinions expressed herein are statements of our judgment on the date
appearing on this material only and are subject to change without notice. We endeavor to provide updates on a
reasonable basis of the information discussed in research reports, but there may be reasons which prevent us from
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Additional Information: Any additional information, if applicable, supporting this recommendation may be furnished
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Brian Bolan
Research Analyst – Technology

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