Yahoo (YHOO) A 'work in progress'

by Geoffrey Seiler, editor BullMarket.com

Based on valuation and solid improvements in some areas, we think Yahoo (YHOO) remains a "Buy."

The company is still a work in progress and investors need to be patient, as the the payoff won't really come about until the company's efforts translate into solid, consistent sales growth.

The company reported mixed Q2 results last night after the closing bell. Revenue fell short of the Wall Street consensus but EPS beat by a penny.

There were signs of strength in the company's display advertising business, though a drop off in display ads in late June was attributed to end-of-quarter expense management on the part of advertisers.

Search remains a work in progress as the company gained a little share but the increased number of searches didn't translate into revenue growth.

This was another mixed quarter from Yahoo. We think the company is generally making solid incremental progress and management is to be commended for diligently managing costs.

Cost control was certainly a foreign concept at Yahoo in the pre-Bartz years. While that's a positive, Yahoo's stock is not going to take off until the company can show consistent top-line growth to go along with the expense management.

Looking at the balance sheet, Yahoo ended the quarter with roughly $3.8 billion in cash and marketable debt securities, or about $2.70 per share, and zero debt.

It repurchased roughly 32 million shares for $496 million. Year to date, including July, it has bought back 63 million shares for $973 million, an average price of $15.40 per share.

Its 2006 share repurchase authorization has now been fully utilized and on June 24th the board approved a new $3 billion authorization.

Cash flow from operating activities was approximately $347 million in Q2 and $491 million for the first six months.

Finally, management noted that as of June 30th, the pre-tax value of its 35% stake in Yahoo! Japan and 29% indirect stake in Alibaba.com was just over $11 billion, or approximately $8 per share.

These figures are based on public market quotes and do not include estimates of the value of Alibaba Group’s privately held businesses, thus the estimate is likely on the low side.

At this point we have to take management at its word that the late-June drop off in display advertising was an anomaly. CEO Bartz's explanation seems plausible, but we won't really know for sure until Q3 numbers are in.

Investors are also still waiting to see the payoff from the search deal with Microsoft; we believe it will happen but investors won't be convinced until the evidence is in.

With the company's cash and investments totaling about $10.70 per share (about $2.70 per share in cash plus the $8 for the Asian stakes), Yahoo's stock is dirt cheap.

The market is basically saying a business that still generates over $1.3 billion in yearly EBITDA with about a $1.9 billion run-rate based on Q1 is worth about $4.5 billion, or a little over 3 bucks a share.

Based on the Q1 run-rate, that a multiple of well under 3x, which is extremely low for almost any type of business, let alone an Internet company.

To think of it another way, Yahoo's stock is now a cheap China Internet play via its stake in Alibaba, and investors are getting Yahoo thrown in at a deep discount. Our Target remains $22.

Learn more about this financial newsletter at Geoffrey Seiler's BullMarket.com.