Yahoo Needs Direction, for Everyone's Sake

Between the patent litigation and a separate fight to seize control of the board, it is hard to fathom what is happening inside Yahoo Inc. (Nasdaq: YHOO). The once-dominant Internet company continues to search for the right strategy to reclaim territory on the Web, and so far the results have left investors confounded.

On Monday, Yahoo filed a patent infringement lawsuit in US District Court, Northern District of California in San Jose against Facebook (Nasdaq: FB) regarding Web advertising and other technology. The litigation comes as Facebook prepares to go public. Yahoo is seeking unspecified damages.

In a statement sent to me via email, Yahoo responded, "These technologies are the foundation of our business that engages over 700 million monthly unique visitors and represent the spirit of innovation upon which Yahoo is built. Unfortunately, the matter with Facebook remains unresolved and we are compelled to seek redress in federal court."

The legal fight is one of the latest actions in the rather hard to follow strategy at Yahoo. For now, investors seem neither thrilled nor gloomy about the company's recent maneuvers. Shares of Yahoo traded around $14.70 yesterday, not quite midway between the 52-week low of $11.09 and the high of $18.84.

Yahoo needs clarity, according to one analyst who sees the company on a foggy path. For the year ended December 31, 2011, the company reported $1.05 billion in net profit on revenue of $4.98 billion. That compares with net profit of $1.23 billion on revenue of $6.32 billion in 2010.

Breaking down its revenue streams, Yahoo saw its search engine business shrink to $1.85 billion in 2011 from $3.16 billion in 2010. Yahoo said that decline, in part, stemmed from revenue sharing per its search engine alliance with Microsoft Corp. (Nasdaq: MSFT).

Rick Summer, an analyst with investment research firm Morningstar Inc. (Nasdaq: MORN), said revenue sharing with Microsoft is only part of the issue as Yahoo loses market share in the search engine sector. "More importantly, (Yahoo) isn't investing in core search," he said, regarding audience development. "They need traffic and people clicking on ads."

In addition to not beefing up its search business, Summer said Yahoo has done little with online ad business Right Media, which it acquired in 2007. "The folks we're talking to have suggested that Yahoo has not invested heavily enough in that platform," he said.

There have been rumors about Yahoo considering a sale of such online advertising assets, a possibility Summer is not excited about. "It would signal that Yahoo has decided they really are a content and media company only," he said. "It is very tough to drive long-term, sustainable advantages in the pure content business."

Summer also questioned the overall direction Yahoo was taking. "What does management spend their time on?" he asked. "Monetizing IP? Divesting certain key assets? Investing in new businesses?"

Lawsuits are not helping to clear up that confusion. The current litigation between Facebook and Yahoo, he said, puts a strange spin on the relationship between two companies that historically worked as partners. "There is a Yahoo news app within Facebook that is pretty widely used," he said.

One way to regard the patent lawsuit, he said, is Yahoo searching for ways to monetize all of its assets, but there seems little chance for a swift resolution. "From the folks we've talked to, it is highly unlikely they will reach the number that they've asked for from Facebook," Summer said.

Meanwhile, a campaign led by Daniel Loeb, CEO of hedge fund Third Point, to take control of Yahoo's board compounds the confusing situation at the company. If Loeb's efforts lead to turnover on the board of directors, Yahoo could see yet another shift in strategy. "That should be a concern for any investor," Summer said. "Not really sure who is driving this train."

He said Yahoo needs to create a business that has advantages over its rivals and repeatable cashflow streams. Currently the company seems to be clamoring for focus. "We have a lot of efforts going on that are completely unrelated to each other," Summer said. "There is so much murkiness going forward for this company."

He said he believes Yahoo shares are worth $17. However, Morningstar is encouraging its clients who do not hold a position to stay away for now. "There is way too much uncertainty about where it's going," Summer said.