"Given our overall enthusiasm for the growth prospects of online advertising, both branded and search, we do not see a lot of downward pressure on Yahoo shares," wrote Analyst Lauren Rich Fine in the report.
While Merrill Lynch stated that shares are "likely to remain volatile," it also concluded that "there is good support for the shares at the current price," due to the continued strength of online advertising. The report stated that online advertising is expected to rise from 3.7 percent of total U.S. advertising to 5.3 percent within five years. Nonetheless, the report came out neutral, based on Merrill Lynch's conclusion that Yahoo!'s valuation was high, "providing little room for further multiple expansion."
Two recent Yahoo! hires--former ABC executive Lloyd Braun, and Neil Budde, founding publisher of the online version of The Wall Street Journal--telegraphed to Merrill Lynch that Yahoo! intends to create more original content. Fine concluded that Yahoo!'s increased focus on content was a strength-- rendering Yahoo! "a more diversified company" than main competitor Google--but also noted a potential drawback to the strategy, "a higher future cost structure."
Merrill Lynch also anticipates that Yahoo! will have strong growth opportunities abroad, particularly in Korea and China. Additionally, the report stated that Yahoo! expects to introduce sponsored search services in Canada, Brazil, Taiwan, China, and Hong Kong by the end of the year.
On the downside, the report noted Yahoo! could lose as much as $100 million in revenue if and when Microsoft develops a system for providing paid search results. MSN, which recently released a beta version of its own search engine, currently obtains paid search listings from Yahoo!'s Overture, but that contract is due to expire in June 2006.