At Yahoo, job cuts are the good news

October 21, 2008: 9:12 PM ET

By Yi-Wyn Yen

You know it's a bad quarter when the most encouraging news you offer is job cuts.

During Yahoo's third quarter earnings call Tuesday, chief executive Jerry Yang made an unconvincing argument that the company is "well positioned for future growth." Yahoo reported net sales and earnings for the third quarter that fell well below the Street's consensus.

And Yahoo (YHOO) is bracing itself for a bleak fourth quarter. The company adjusted its year-end gross revenues estimates to reflect worsening conditions. The company projected gross revenues of $1.77 billion to $1.97 billion. And for the second straight quarter, Yahoo reduced its year-end gross revenues estimates by $175 million to $475 million. To get through the "tough environment," Yang said the company will lay off about 1,500 employees, or 10% of its workforce, before the end of the year. Yahoo's shares jumped 7% in after-hours trading to $12.95, likely because of the cost-cutting, said one analyst.

But it's hard to see how Yahoo can slash its way back to greatness, or what other path it could take to get there.  Yahoo's management has been criticized for not taking Microsoft's offer to buy the company at $31 a share earlier this year. The stock has fallen 54% since both parties ended negotiations in mid-June. And the alternative strategy for growth Yahoo proposed, a search advertising deal with Google, is now tied up by the feds.

Investors are losing patience for new board members like Carl Icahn to find ways to boost Yahoo's sagging stock price. Icahn could not be reached for comment on Tuesday.

Wall Street analysts grilled Yang on whether cutting employees was an acceptable alternative to a Microsoft (MSFT) deal.

Yang said that "getting Yahoo more fit" was a way to boost Yahoo's sagging stock price. "We think that taking aggressive actions on cost structures is one of the ways to unlock shareholder value," he explained. "By streamlining activities…we hope to come out of this stronger and more nimble."

Analysts say they are skeptical that cost cuts and Yahoo's reliance on APT, its new display advertising platform launched last month, will be enough for the company to weather a stormy economy.

Yahoo's executives were vague on merger talks with AOL (which is owned by Fortune's parent company Time Warner) and its search agreement with Google (GOOG). Yang said the company is working with the Justice Department, which is reviewing the case for antitrust concerns, to outsource some search ads to Google "as soon as possible."

"Clearly there is going to be increased pressure on Jerry Yang to take more drastic measures to make the stock work in the short term," said Jefferies analyst Youssef Squali. "[Carl] Icahn and his two lieutenants and other independent board members should be displeased with the turn of events."

Yahoo reported net sales of $1.33 billion for the third quarter, which were below Street estimates of $1.37 billion. Yahoo earned 4 cents a share, below the Street consensus of 9 cents.

"The Street's not happy. Being in a middle of an ad recession and not putting up decent numbers isn't going to help," said Christa Quarles, Thomas Weisel's Internet analyst.

An economic recession spells trouble for Yahoo, the bellwether for online display advertising. The growth rate for display advertising is expected to slow down in 2009. Analysts predict that marketers will spend more on search advertising than display next year because search is considered a more accountable way to directly reach consumers.

Yahoo's share in search is steadily declining while Google's continues to grow. Yahoo had 20% of the U.S. search market for September and Google had 63%. Yahoo has lost 15% of its share in search from the same period a year ago, according to comScore.

Yahoo President Sue Decker said internal statistics show that Yahoo is actually faring better than comScore suggests. Yahoo made more money from search than display for the first time. The company grew its search revenue by 17% for the third quarter to $438 million while earning $435 million, a 3% increase, from selling display ads.

However Decker admitted that Yahoo's search revenues were not enough to compensate for the decline in display advertising. Decker said display advertising started souring by mid-August.

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