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Yahoo: Bargain Or Big Trouble?

For a couple of years now, investors looking for affordable blue-chip Internet stocks have had to pass on portal giant Yahoo , even as the company was being touted as one of the few certain winners in the Internet economy.

The reason, of course, was that Yahoo shares have been overpriced, even relative to robust revenues. In October 1999, after releasing third-quarter numbers, YHOO was valued at 96x trailing 12 months' revenues, and its share price was $175.

Back then I wrote, "It's likely that Yahoo's stock price will come down to reflect the company's true value faster than revenue can grow up to that value."

It's fair to say that prediction has come true, with some help from a bursting industry bubble. By October, just one year later, YHOO's share price and valuation had been cut by more than half, to $84 and 47x TTM revenues, despite steady earnings and estimate-topping quarterly performances.

Today, with recent downgrades applying even more pressure, YHOO is less expensive than it has been for a long time. Shares closed Thursday at a 52-week low of $34.94, giving YHOO a valuation of 19.6x TTM revenues of $995.1 million.

So is it time to buy into Yahoo?

Not quite. For while YHOO now is cheaper than other blue-chip Internet stocks such as eBay (24x), i2 Technologies (23x) and Check Point Software Technologies (59x), companies such as America Online (14x) or Cisco Systems (16x) remain better deals.

Further, though Yahoo and Cisco are roughly equivalent in cost, that doesn't mean their respective stocks are equally attractive. The main reason: Revenue outlook.

Despite regular outbursts of analyst anxiety regarding its rate of growth, Cisco sales continue to accelerate. Figures released last month for the networking giant's first fiscal quarter show a 66% revenue increase over the year-ago period. That's up from 61% year-to-year revenue growth in Cisco's fourth quarter, and 55% in Q3.

Yahoo, in contrast, has seen revenue growth begin to slow this year. In the most recent quarter, ended Sept. 30, Yahoo sales were just 90% more than sales in the third quarter of 1999. I say "only" 90% because revenue growth in Q2 was 110%, and it was 120% in each of the two quarters before.

This trend lends much credence to market concerns about a slowdown in online advertising spending, which comprises 85% of Yahoo's revenues. Indeed, Yahoo and Internet ad services market leader DoubleClick are seen as the biggest victims of the market's gnawing skepticism about business models built primarily on Web advertising.

Already this week YHOO has been rocked by downgrades: First by Merrill Lynch analyst Henry Blodget cut sales forecasts for the company for the first half of next year. Then WR Hambrecht analyst Derek Brown reduced Yahoo to a "neutral" rating, again citing questions about online advertising and urging investors to "wait until the smoke clears."

That sounds about right to me. I believe Yahoo is a strong company, but nobody knows how severe industry-wide cuts in online advertising spending cuts will be over the next year. Thus, I suspect more downward drift from YHOO until, as Brown puts it, the smoke clears.