I don’t Yahoo!

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Expect Yahoo’s Turnaround to Turn South Soon

Yahoo! (NASDAQ:YHOO) has gotten a little bit of its swagger back recently.

YHOO stock is up double digits in the past week thanks to an upgrade by Cantor Fitzgerald coupled with the elimination of a few underperforming products that investors cheered.

These gains push the six-month return for Yahoo stock above 50%, fueled by improved earnings reported in January and optimism over the company’s first revenue increase in four years.

As a result, shares are back to levels not seen since early 2008.

But this momentum might not last. Anyone who understands the underlying challenges for both digital media generally and Yahoo stock specifically should admit that things are anything but rosy. Much-loved CEO Marissa Mayer may talk a good talk, but those of us in the web publishing industry know that there are a host of problems she has not yet addressed and may have trouble fixing.

Eventually, the turnaround will turn south as a result.

I could talk fundamentals like a soft revenue outlook, with a meager 3% sales growth projected this year and in fiscal 2014. I could talk valuation that includes a forward price-to-earnings ratio pushing 19 and a price-to-sales north of 5. I also could talk about sentiment, such as the risk of overheating after a stock run-up or the risk of Mayer’s honeymoon ending as her tenure hits the one-year mark this summer.

But longer-term, I think the risks are more systemic. Here’s why I’m skeptical of Yahoo both an investor and a self-proclaimed digital media nerd:

The Portal Model Is Dying

Yahoo! users are most commonly driven deeper into the site by flashy homepage images or headlines that grab them as they check their mail. But that’s a very old-school model that is under attack from aggregation sites like Huffington Post as well as social media outlets like Twitter and Facebook (NASDAQ:FB).

In fact, Facebook now has more unique monthly visitors than the entire family of Yahoo! sites, as well as the universe of MSN.com sites run by Microsoft (NASDAQ:MSFT). HuffPo isn’t far behind. Furthermore, ComScore data parsed by Kara Swisher over at All Things D shows mail traffic was down 16% year-over-year in November and 12% in December. Other “worrisome” metrics she notes include “[p]ercentage of reach, total minutes, total page views, total visits and more.”

Sure, MSN and Yahoo! still maintain massive Internet footprints. But the threat to the portal model is real and is not going to relent. The recent revamping of the Yahoo! homepage with a news feed and Facebook Connect does little to change this paradigm.

Content Wars Are Heating Up

As a result of declining portal traffic, the related verticals in the Yahoo! universe that span music, movies, games and travel have seen big traffic dropoffs recently.

But an equal threat to specific content verticals is increased competition from both professional and amateur sites.

I really like the Yahoo! Finance vertical — particularly the Breakout stuff with pithy pundit Jeff Macke. But I also am constantly amazed by the quality and depth of off-the-beaten-path finance blogs. Whether it’s one of my daily reads (like Tim Knight’s Slope of Hope) or a site I stumble upon based on the recommendation of “linkfests” like Abnormal Returns or Felix Salmon and Ryan McCarthy’s Counterparties, it’s obvious there’s a host of smart people saying smart things outside of mainstream digital media.

An extra layer to this comes from sites like Business Insider or Huffington Post that aggregate content from the little guys under the guise of being an information filter.

There is a tooth-and-nail fight for eyeballs right now, and quality content will always win. Jeff Macke & other folks at Yahoo! might have staying power … but it’s willfully naïve to think everyone there has what it takes to keep their particular vertical within YHOO respected, well-read and profitable.

Monetization Is Murder in 2013

Even if Yahoo finds out a way to mitigate its diminishing portal power and establishes must-read sections with quality content, there still are no guarantees it will make more money.

That’s because monetization of web content is murder for all digital media businesses.

Yahoo and online advertising behemoth Google (NASDAQ:GOOG) were both shaken at the end of 2012 thanks to fears over declining “cost per click” metrics on display ads. And while Google reported in January that it managed to grow revenue and profit in Q4, cost per click measures still were soft.

Furthermore, mobile advertising continues to elude clear paths to revenue. Mobile ads typically are much less responsive and command as little as 20% of conventional desktop ad rates, but traffic is increasingly moving to smartphones and tablets.

Top it off with the continual struggle between paid and free — including the porous paywall, the “long nag” of subscription-supported products and the clear disparity between what you pay and what you get — and, well … Yahoo has a very tough row to hoe.

That’s not to say Yahoo can’t figure things out. But it naturally has to figure out a measured way to transition between the old and the new world.

Lots of Distractions and Little Growth

One final point on innovation and agility: Yahoo admittedly is trying to clear the deck of underperforming efforts. This comes after the death of Yahoo Messenger and some other efforts last year, and capitulation on Yahoo search in 2009 that paired its search with Microsoft Bing.

But these kinds of restructurings are painful, and there’s still a lot of fat to trim. Consider that an insider said in 2012 that Yahoo could kill 10,000 employees from the payroll and be fine. That was right before Mayer took over, and the axe has failed to fall.

Plus, any right-sizing is just a short-term boost to profitability — and judging by the surge in Yahoo! stock, that has already been priced in for the most part. The challenge is really replacing troubled projects and wasted energy with new efforts and avenues for growth.

As of yet, there is no big culture shift that warrants enthusiasm. Giving out iPhone 5s and making cafeteria food cool again is nice for morale, and closing lackluster efforts of the past is good for productivity, but there’s no clear growth plan.

Yahoo’s clearest path to growth — a foothold in Asia via a big stake in Alibaba Group — was sold in 2012 for $7 billion. The deal was troubling, as Yahoo! derives about 75% of total revenue from the Americas and global growth is the clearest path to higher revenue. But even more disturbing was that the company burned much of that cash on a $5 billion buyback scheme, and probably will squander the rest on inevitable layoffs.

Yahoo can continue to play whack-a-mole with troubled products or staffing inefficiencies. But at the end of the day, that’s not growth.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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