Internet search and content provider Yahoo (click ticker for report: ) reported first-quarter results that were mediocre. Revenue ex-TAC (excluding traffic acquisition costs) was flat year-over-year, falling short of consensus estimates. Earnings per share easily exceeded consensus expectations, rising 52% year-over-year to $0.35. Yahoo provided non-GAAP earnings per share of $0.38 that excluded stock-based compensation expense.
Unfortunately for shareholders, the EPS increase was mostly the result of a 10% reduction in share count, a reversal of one-time charges, and a significantly lower tax rate. Non-GAAP operating income fell $7 million year-over-year to $224 million. Operating cash flow also declined to the magnitude of 26%, while free cash flow also declined 20%. In our view, the quarter was not nearly as strong as headline results made it appear.
Given our preference to allow changes to occur at companies, we’re willing to give CEO Marissa Mayer time to work on the turnaround. Some have compared the situation to Ron Johnson at JC Penney (click ticker for report: ), except we believe the market is being much more patient with Mayer because we haven’t seen the same precipitous decline in sales. Additionally, Yahoo’s financial position is far more favorable with $5.4 billion of cash, cash equivalents, and marketable debt, as well as highly-valuable stakes in Yahoo Japan and Alibaba. Conversely, Yahoo is similar to JC Penney in the sense that the company wasn’t going to thrive under its previous strategy. For the sake of Yahoo’s survival, we hope the board remains patient.
Regardless, Yahoo made some solid strides towards revamping its business during the quarter. The site’s mobile user base soared from 200 million users at the end of 2012 to 300 million users at quarter end, and Mayer noted that the firm experienced a 50% increase in daily active users on apps after launching new offers for iOS, Android, and Windows 8. Flickr also re-launched, leading photo uploads to increase 50% quarter-over-quarter. We’ve noticed some enhancements to the firm’s email offering, but it remains unclear if the firm will be able to strike back against the rise of Google’s (click ticker for report: ) Gmail.
From a revenue standpoint, display ads remain weak as advertisers migrate to mobile platforms and competitors. Yahoo partnered with Google to place ads on some of its properties to capitalize on AdSense’s ability to display superior advertisements. We doubt this will hurt the firm’s existing partnership with Microsoft (click ticker for report: ) and Bing, though it does show the company’s willingness to work with every company in the tech universe. The firm also has multi-year partnerships with Facebook (click ticker for report: ) and Apple (click ticker for report: ). Rumors have surfaced suggesting Apple wishes to deepen its relationship with Yahoo, which could help the company further eliminate Google from the iPhone. We believe this could provide some nice upside for Yahoo, especially considering that we think the iPhone will maintain robust market share.
Overall, the financial results at Yahoo weren’t great. In fact, if Yahoo fails to improve its business, its share buyback program could become value destructive (should intrinsic value decline). Turnaround situations, particularly those like Yahoo where a highly-praised CEO takes the reins, are notoriously difficult to predict. We like Mayer, and we think she’s correct in changing Yahoo’s strategy. However, we think the stock is fairly valued at this time.