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Verizon and Yahoo: Low Risk, Medium Reward

Verizon's Yahoo acquisition will pay itself back on a margin basis in about 4 years and while there isn't massive upside, there's very little downside.
AOLHoo-3

On Monday July 25th Verizon announced its $4.83 billion acquisition of Yahoo’s core business. A preliminary analysis shows that the combined firm would breakeven in about 4 years on a margin basis. What’s more, this doesn’t even take into account three factors.

First, digital ad revenues are growing quickly. They are expected to grow 15% this year and another 11% the following year according to eMarketer. Though challenging the two elephants in the room – Google and Facebook – will be difficult, there’s enough room to carve out a profitable niche. AOL / Yahoo would own roughly 8.3% of digital spend in the US, which equates to $5.6 billion in revenue. Even if we account for the natural decline in Yahoo’s market share (especially from publishers that are skittish about Yahoo’s future) there’s still about $5 billion on the table for the combined firm. Using AOL’s last stand-alone 10K to find a proxy for ad-margin means about $1.2 billion in margin or roughly 4 years in payback. Put another way: 4 years is a conservative estimate for the margin-based payback for Yahoo, even including the $1.1 billion Verizon’s paying for Yahoo employees’ restricted stock. Note that this doesn’t take into account AOL’s purchase price.

Second, Verizon has the ability to combine their own broadband / wireless / STB data collection with AOL / Yahoo’s ad-tech. This caused a minor outcry when Verizon first started discussing it two years ago but the revenue upside here is clear: other than your utility and credit card company there are few organizations that have a more complete picture of your life than triple-play telcos (I’d say quad play but I don’t really count fixed line telephony anymore). In addition, Comcast has been in talks to use set top box data to increase advertisers’ ability to target consumers – something Verizon should be able to replicate.

Third and last, this is a relatively small bet for Verizon, who almost generated Yahoo’s purchase price in profit in the first quarter of 2016 alone (~$4.31 billion). Assuming they can learn something from Verizon’s ability to execute, I believe the combined firm is well positioned to expand its digital marketing footprint.

The newly-combined entity will report into Marni Walden, who is an EVP at Verizon and President of Product Innovation and New Businesses, via Tim Armstrong, who will directly head up AOL-Yahoo. I’m sure Marni and Tim are highly capable but here are my major concerns for what could hinder Verizon’s grand ambition.

First, Verizon will be absorbing ~8,800 people. There will be some natural attrition as redundant functions are let go, but more important will be retaining key Yahoo employees that don’t want to work at Verizon. Doing so will be a key task for Marni and Tim as they lay out a vision for the combined entity. In specific, their goal should be to at least stem the natural exodus of top talent that typically occurs post-exit.

Second, integrating Verizon’s formal management culture with Yahoo’s informal one could prove challenging. This is especially true since Verizon will now have to contend with integrating Yahoo and AOL while figuring out the combined entity’s strategy. This is a softer concern but a very real one (remember AOL and Patch?).

Lastly, the combined entity will require a war chest to acquire companies across the ad-tech stack to simply tread water against Google and Facebook. The problem is that between Verizon’s heavy post-Vodafone debt load and its ~$20 billion in annual network capex, finding additional cash to fund this war may prove difficult at times. This isn’t to say Verizon won’t fund M&A activity. It’s more a question of when there’s limited capital and only $1 left to invest, does it go to network or does it go to ad-tech?

All that being said, I’m optimistic about Verizon / AOL’s acquisition. It might have taken 22 years for AOL to get control of Yahoo (the deal is expected to close in early 2017) but it’s finally happening: two early internet pioneers are being brought together for less than a tenth of the maximum market cap of Yahoo alone (~$125B). It’s a watershed moment on another front as well: this is Verizon’s second marquee acquisition in its attempt to move from analog to digital. Verizon has acquired firms across the ad-tech stack including Millenial Media but the digital marketing space is evolving quickly and this acquisition shines a bright, harsh spotlight on Verizon as it looks to execute. Now it’s time to deliver.


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