The Yahoo-Tumblr deal is a $1.1 billion gamble aimed at rejuvenating a stagnating business, but is more likely to end up a costly mistake.
The deal, announced today (Monday), is by far Yahoo CEO Marissa Mayer's biggest – and riskiest – acquisition yet.
Yahoo! Inc. (Nasdaq: YHOO) wanted access to Tumblr's 117 million users, most of them teens and young adults, to give it a beachhead into the ever-more important world of social media.
Tumblr has grown rapidly by making it easy not only to create blogs, but for Tumblr users to follow and share one another's posts.
But Tumblr, like so many other social media companies, is not exactly a money machine. Analysts estimate the company's 2012 revenue was just $13 million, making it a pricey acquisition indeed.
"Even if revenue was $100 million, it means Yahoo paid 10 times revenue," BGC Financial analyst Colin Gillis told Reuters. "Ten times is what you pay to date the belle of the ball. It's on the outer bands of M&A."
The Yahoo-Tumblr Deal is an Act of Desperation
While the Yahoo-Tumblr deal is a long shot, there's little debate that Yahoo needed to do something dramatic.
Lately, growth for Yahoo has proved elusive; in recent years revenue has stagnated around the $5 billion mark.
And the company's Websites have not adapted well to the mobile world of smartphones and tablets, which is how more and more people access the Internet these days.
Yahoo is betting that Tumblr, which it hopes to further monetize with targeted advertising, will add to revenue as well as expand its footprint in social media.
"[Yahoo's] fundamentals have been subpar for numerous years, in part because of the company's missing presence in Social and Mobile. Tumblr may help [Yahoo] develop that presence," RBC Capital Markets analyst Mark Mahaney said in a note.
Why the Yahoo-Tumblr Deal Could End in Tears
But while the Yahoo-Tumblr deal may look like a good move to Yahoo executives now, high-dollar tech mergers have a funny way of going spectacularly sour.
That tragic list includes Hewlett-Packard Company's (NYSE: HPQ) acquisition of Palm for $1.2 billion in 2010 in the hope of using its WebOS in mobile devices. But a year later HP pulled all its WebOS products, and in February sold off its remnant to LG Electronics.
Microsoft Corp. (Nasdaq: MSFT) has made many questionable acquisitions, but one of the worst was its purchase of display advertising company aQuantive in 2007 for $6.3 billion. The hoped-for synergy never worked out, and last year Microsoft was forced to take a $6.2 billion write-down on the deal.
And Yahoo itself is already on the list multiple times, most notably for its acquisition of web-hosting company Geocities in 1999 for $3.57 billion. Yahoo implemented policy changes that disenchanted users, who departed en masse over the next decade. Yahoo shut Geocities down in the U.S. in 2009.
When a tech deal is a good one, it's immediately obvious to everyone. Two that come to mind are Google Inc.'s (Nasdaq: GOOG) acquisition of YouTube in 2006 and Ebay Inc.'s (Nasdaq: EBAY) purchase of PayPal in 2002.
But most tech deals with obvious flaws from the start end as failures.
And this Yahoo-Tumblr deal has more than its share of landmines.
For one thing, monetizing Tumblr will mean a lot more advertising on the site, which risks alienating users, most of whom are young and anti-establishment. Yahoo will probably need to sweeten the pot by offering to share ad revenue with Tumblr users, much like Google does with YouTube videos.
Yahoo's reputation for ruining many of the companies it acquires such as photo-sharing site Flickr is already making Tumblr users nervous.
More troubling is that much of the material on Tumblr is racially offensive and sexually oriented – not exactly the sort of content that appeals to most advertisers.
And even if the Tumblr business does manage to grow revenue, Yahoo still has to find a way to integrate it with the rest of its business, which is the only way this gamble pays off.
"Yahoo is not likely to see a revenue impact from Tumblr in 2013 or 2014," RBC's Mahaney wrote. "That makes this a long-shot/long-term investment, the ROI on which won't be clear for several years."
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