Yahoo Earnings: Light at the End of the Tunnel?

It’s no secret that the downturn in online advertising has been unkind to Yahoo’s balance sheet, but some analysts are hopeful that the worst may be over.

The Web pioneer is due to report its third-quarter earnings tomorrow after the close of the market, shedding more light on what industry observers hope is a resurgent advertising sector.

“Yahoo is well leveraged to an ad rebound in both display and search,” Barclays analyst Doug Anmuth wrote today in a research note.

That positive tone is supported by the recent news from another bellwether in the online advertising space. Last week, Google (NASDAQ: GOOG) reported a seven percent annual increase in revenue with its third-quarter results, which was enough for CEO Eric Schmidt to proudly declare that the company was confident enough to begin hiring and making acquisitions again.

Under the leadership of CEO Carol Bartz, Yahoo (NASDAQ: YHOO) has been undertaking something of transformation, attempting to redefine itself as an online hub where users can personalize their Web experience. Yahoo recently launched a major multinational branding campaign to spread the message of personalization.

In that light, Yahoo appears to be staking much of its success on building out its content and monetizing it through display ads. The flip side of Yahoo’s move toward content and display ads has been its willingness to effectively exit the search business, at least from a technological standpoint.

In July, the company announced that it had struck a deal with Microsoft (NASDAQ: MSFT) where the software giant would take over the engineering platform underpinning Yahoo’s search engine and merge it with its own Bing product, while Yahoo would handle ad sales.

That deal has come under the predictable regulatory review, though it got a boost today from the American Association of Advertising Agencies (4As), which sent a letter to the Department of Justice calling for the antitrust authorities to quickly clear the partnership.

“We believe that Yahoo and Microsoft’s proposal to combine their technologies and search platforms is good for advertisers, marketing services agencies, Web-site publishers and consumers,” 4As President and CEO Nancy Hill wrote.

The chief executives of the four leading advertising holding companies – Publicis Groupe, WPP, Omnicom Group and the Interpublic Group of Companies – also signed the letter.

Last year, the DoJ scuttled a far more limited search deal between Yahoo and Google, a decision that was likely influenced by a torrent of opposition among members of the advertising industry.

Barclays’ Anmuth takes the Microsoft deal as a positive for Yahoo’s margins, given that it would still net a heavy share of the proceeds from search ads served on its sites while offloading the considerable technical cost associated with its search engine.

In the meantime, the rebound in online advertising is likely to yield stronger results in the fourth quarter than the earnings Yahoo will report tomorrow, he said, which could result in improved guidance for the final period of the year.

“If Yahoo were to pull back on light Q4 guidance, we’d be adding to the position as we believe the company is beginning to benefit from an uptick in online advertising, and we expect a positive tone at the October 28 investor day,” Anmuth said.

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