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IN THE CATBIRD SEAT

Managing triple-digit growth, hefty margins, and global expansion, Yahoo CFO Gary Valenzuela is the envy of his Internet peers.
George Donnelly, CFO Magazine
April 1, 2000

Gary Valenzuela is leading a charmed life. He's the chief financial officer of Yahoo Inc., a high-flying dot-com with a market value hovering over $90 billion--more than that of Ford or General Motors. And the $16 million in options he exercised last year is but a small portion of his holdings in the Santa Clara, California-based global Internet media company.

But Valenzuela's good fortune is about more than steering finance at a company with a runaway stock price. Since the fourth quarter of 1996, Yahoo has consistently made a profit. Last year, it earned $61.1 million on sales of $588 million--rare numbers for an Internet company. At a time when many E-commerce outfits find themselves under pressure to surface from red ink, Yahoo is thriving under a proven model, maintaining a healthy current ratio of 4.6.

Yahoo has transformed its first-mover advantage as a search engine and portal into a beloved brand, and now that brand is paying dividends. Unlike many Internet companies buried in customer acquisition costs, Yahoo grows increasingly efficient in managing its marketing budget. The dot-com also has a natural edge over other business-to-consumer Internet companies: it carries no inventory. Thus, it enjoys gross margins of 86 percent, and its revenue per employee for 1999 was $432,000, up by over a third from 1998.

While Yahoo's stock parties on, inside the company the 42-year-old Valenzuela is known as "Mr. Conservative," a sobriquet he likes. He joined the company early in 1996, after stints with several other Silicon Valley technology firms. He took Yahoo public in the spring of that year. Ever since, Valenzuela has helped bake profitability into the corporate culture with a strong set of controls. And he displays the same disciplined approach to Wall Street, preaching consistency and sticking to established ground rules.

Despite the company's stellar track record, maintaining success in the Internet arena remains a high-wire act. While its bottom line may distinguish Yahoo from most of its peers, the company is still valued because of its top- line potential. Despite pressure to complete a deal after the America Online­Time Warner merger, Yahoo appears content to remain unmarried to a single, major media outlet. As senior editor George Donnelly learned during a recent interview with Valenzuela, Yahoo has good reasons to be a wallflower--at least for now.

Unlike at many dot-coms, at Yahoo the bottom line seems to matter.
Profits matter. We've thought that way since the beginning. Not many people appreciate this, but we've been profitable on a pro forma basis since the fourth quarter of 1996. It was a conscious decision by the management team to build a profitable business.

There are three reasons we did that. Number one, [being profitable] is a strong operating discipline. People understand how important the budgeting cycle is. They understand how important it is to make your numbers. The second reason is that if you lose money for too long, people grow up in that environment; they haven't been able to make money and maybe don't know how to make money.

The third reason is we've always viewed ourselves as a leadership company, and we felt profitability and financial leadership went hand-in-hand with what Yahoo is all about.

How does the fact that you actually have some "E" in your P/E affect your valuation? Since so many other Internet companies don't have earnings, do investors put Yahoo in a different category?
The earnings do differentiate Yahoo from a lot of the other players. Lately, Wall Street has been a lot tougher on companies where there's a question of whether the business model is viable. There is no such question here.

How efficient is Yahoo at customer acquisition? Have you reached a critical mass that creates a marketing momentum of its own?
On the Web, it's all about achieving scale. Scale in terms of users--we had 120 million in December. Scale in terms of page views--we had an average of 465 million page views per day in December. We have more than 3,550 advertisers, 9,000 merchants. Scale is an important concept, because it is the basis for anything you do on the Web for monetization.

The scale cycle starts with a strong brand to attract users. Then attracting more and more users, which is more and more attractive to advertisers, and more and more attractive to merchants. Then you can add more services, which is more attractive to users. Getting that self-reinforcing scale working to your advantage is incredibly important, and we've benefited greatly from a strong brand.

A strong brand means you can spend less on marketing.
Right. A couple of years ago, our marketing expense was 70 percent of revenue; it's gone to a low of 30 percent of revenue. But if you look at our P&L, marketing is the biggest line item, and it's going to continue to be. We're not going to get caught underinvesting in this area. We're making sure we're investing in the brand in each country that we're in--and we now have 21 non-U.S. Yahoo properties.

How much time do you spend dealing with Wall Street?
It takes up a lot of my time. Today, we have 28 sell-side analysts following Yahoo, and, of course, a lot of buy-side analysts. We're blessed with great coverage.


Obviously, you don't have to ask for attention, but do you have a philosophy of shaping Yahoo's story on the Street?
We are proactive in our communication with the Street. We are consistent, we have an open dialogue, and we're always present at the many conferences throughout the year. Last year, we did about 25 analysts' conferences. Also--and this is key--from early on we've established ground rules with the analysts. They know what to expect and what not to expect. For instance, analysts know we adhere to certain quiet periods around the end of the quarter. We also don't talk about forecasts of revenue or earnings per share. We talk all about strategy, the initiatives we have going on.

Yahoo's growth is anything but conservative. Your fourth-quarter revenues were up 120 percent from Q4 1998, and overall revenues grew 140 percent in 1999. I was interested to hear you say during a recent earnings call, "These are extraordinary growth rates, which are unsustainable."
Absolutely.

You didn't have to say that.
I definitely did not.

So why did you say it?
Well, I've been saying it for the last two years. It's a consistent message, and it's also in the context of the conservative tone that we've established with the Street. I spend a lot of time trying to get people's feet on the ground in terms of expectations. You can't keep growing at triple-digit percentages, just based on the law of big numbers.

Yahoo's stock was selling around $170 before the recent stock split; the multiple was about 1,500 to 1,600. How do you explain this valuation?
I don't try to explain why the stock price is there, and we don't manage our business around the stock price. We manage our business around performance--executing ahead of expectations, achieving our objectives. The good news is that with our absolute, complete focus on building this business as big as it possibly can be, the numbers today are pretty amazing.

Think about a global business, serving an incredibly large and rapidly growing market-- 120 million "unique" users, meaning people simply logging on to our site, as opposed to subscribing to a personalized service, on a global basis--and what that could be three, four, or five years from now, what the market opportunity is in terms of advertising.

That's one part of the opportunity. The other part is commerce on the Web. It's huge, and growing. If you put that all together and then understand our position and the strength of our brand, there is a real value proposition.

So the valuation isn't crazy?
You're saying it. I'm just listening. [Laughter]

Obviously, the standard valuation models project three to five years out, and who knows what Yahoo will look like then?
Right. And there are a lot of different ways the analysts are looking at valuation. Clearly, they're looking at the profitability, and they're looking at cash flow. Last year this business generated more than $300 million in cash.

Speaking of cash flow, why did the market react negatively to the America Online­Time Warner deal? On one hand, you've got an old- line media company generating a lot of cash. On the other, you've got AOL, which has been profitable for quite some time. Yet the market said, "Why?"
I'm not the perfect person to answer that question. I think the market might be a little shortsighted. That combination is a bold move for AOL--acquire a lot of content assets, acquire cable assets, acquire great brands, and then position itself for more-traditional performance in terms of cash flow. All that on the positive side of the ledger.

On the negative side, companies are still being judged on the ability to grow the top line. And that percentage growth in the AOL­ Time Warner case is naturally going to go down significantly, even though the absolute numbers are amazing.

In the wake of the AOL deal, many people said that Yahoo needed to step up to the plate and make a deal. What do you think about that?
Well, we've heard that, too. [Laughter] Understand that from AOL's point of view, [merging with Time Warner] makes sense. It maintains a proprietary environment in terms of most of its revenues. [Editor's note: Unlike Yahoo, which doesn't charge for its content, AOL derives most of its revenues from connecting subscribers to its proprietary content and services.]

Yahoo has always been purely Web-based, absolutely open, comprehensive, independent. All our acquisitions have been purely Web- focused, either adding functionality or services for our users, adding content, or adding rich media in the case of Broadcast.com.

Certainly we take the competition very seriously. Understand, though, we have over 1,000 content partnerships around the world. So while we haven't necessarily done the big deal, we do have partnerships with ABC, CBS, Fox, Reuters, and so on.

If you do a big deal with a media company, can you really achieve that deal and not limit independence and comprehensiveness--ultimately choice for your users? Possibly you can, but it involves a lot of complexity. In every large acquisition, there is some complexity involved--and it's not in doing the deal, it's in doing the integration. The larger the deal, the more remote the operation, the higher the head count, and so on. This all adds to execution risk and risk in the transaction.


A research note by Paul Noglows at Hambrecht & Quist says the AOL­Time Warner deal could knock the stuffing out of your stock, because suddenly there is this large portal with a new identity and there's Yahoo--and something's got to give. What's your opinion?
Paul is a great analyst, and I think that might have been taken a little out of context. Obviously, he's a strong supporter of Yahoo and of AOL. That's the main point. We've always thought the market is big enough for multiple players. Probably not many more than three global branded Web networks will emerge as the leaders. AOL will be one; that would be my bet. I'd probably put Microsoft into that category as well. We're working hard to make sure Yahoo is in that category.

Yahoo aside, how do you see the Internet world? Is a shakeout coming?
I think it's natural that this industry, like every other industry, is going to go through a period of consolidation. Yahoo is in the consolidator mode, not the consolidatee. We've done 14 acquisitions to date.

A shakeout wouldn't be a bad thing for Yahoo, in other words.
I don't think it would be a bad thing.

Let's return to the issue of profitability. You have 86 percent gross margins--those are classic software margins. What makes Yahoo so light?
The economics of the business are such that we are aggregating content, and it's basically a matter of moving around electronic pages of information and electronic ad banners. If you think about our consumption of 465 million page views per day in December, that's a whole lot of inventory to monetize. Every page is a chance to present a revenue opportunity, whether it's an ad banner or commerce position or sponsorship.

The viewers generate the page views, and the incremental cost of sending a page view to Europe is very, very low. And this massive inventory gives us the ability to take on more and more advertisers and more and more sponsors. Delivery of those pages costs very little.

Your risk factors are fun to read. For example, after Yahoo and other Web sites were attacked in February, now you have to warn investors about the threat of being hacked. Were you prepared for this from a risk- management perspective?
We were prepared for it. We do have business- interruption insurance. We have a pretty comprehensive risk-management program. We don't think of it as a hacker attack; it was a denial-of-service attack. Nobody actually hacked in to Yahoo. No data was corrupted.

The whole advertising thing has a risk factor as well. There have been reports about banner prices going down, and ad saturation. Everyone has a Web page, and everyone is trying to sell. The good news is that there are a lot more advertisers looking to advertise on the Web. Advertisers are attracted by strong brands, whether it's new media or old.

Consumer privacy is a huge issue now. How big of a risk factor is it for Yahoo?
We have focused on privacy for a long time. Fundamentally, it comes down to one major concept: trust. It's something near and dear to Yahoo, to make sure our users trust us. We've been very careful about the way we take information and use it. We have a comprehensive privacy policy that you can get on our Web site.

How do you control the incredible range of vendors that you have? Is it caveat emptor when a user clicks on an icon, whether that vendor will collect information on the user?
It's a complex issue. All of our partners know our privacy policy and know what we will and will not do within the confines of Yahoo. It's very, very clear. Our users know that as well. If you look at our E-mail programs, for example, they're permission-based, opt-in programs. We're very, very careful about not violating anybody's identity.

A lot of finance executives must envy you, as CFO of one of the hottest companies on the Web. Do you get calls from people who ask for advice on taking the Internet plunge? What do you tell them?
I have gotten calls like that. The first thing I say is, "Get on with it," because this is the future. This is an incredibly dynamic space we're in, and it's powerful to be part of a movement that is building a new industry and setting new rules.

What they're going to run into is a very different pace than probably they've ever seen. Everybody has talked about this, and it's real: The pace in this industry is unrelenting. You really have to make sure you have the energy, the ability, and the desire to carry that pace.

You could land on a lemon, though.
Sure. Just because there's a dot-com in the name doesn't mean it's going to be a success. Whether it's the Internet or any other industry, I've always looked for three things: big market opportunity, a strong management team, and a great product or service.

Those sound pretty solid.
Duh. Maybe it's too obvious.




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