The article “Yahoo, Google and Accounting — Web-Search Powerhouses Count Revenue Differently, Making Valuation a Chore” deals with the different methods Yahoo and Google use to report their revenues. In particular, Yahoo and Google treat revenue from small-text advertisements that they place on other companies’ Web sites differently.
Both companies act as technological intermediaries and quasi-advertising agencies, bringing together Web publishers and advertisers. They get paid each time an Internet user clicks on an ad, then give some of that money to the Web publisher on whose site the ad appeared.
Yahoo reports its revenues using the gross method (counting its payment to the publisher as an expense, labeled as a “traffic acquisition cost”), whereas Google only reports the net amount (after it pays the Web publisher).
Using the gross method enables Yahoo to inflate its revenues and to appear faster growing (revenues grew 168%). If Yahoo had used the net method revenues grew only 94%. In Google’s case it is exactly the other way round. However, when it comes to gross profits, Yahoo’s profits appear smaller whereas Google’s profits appear larger.
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The difference in reported revenue can give a much different impression of the strength of a company. Analysts’ use revenue and performance metrics including revenue (e.g. Total Asset Turnover Ratio = Revenues/Total Assets, or Cash Turnover Ratio = Revenue/Cash) to assess past performance, future prospects and comparisons to like companies. If some companies report gross revenues and some companies report net revenues, it makes it difficult to compare businesses that have, ostensibly, the same business model. To remove these distortions, investors often use other measures to evaluate a company, e.g. free-cash flow or cash generated from operations minus capital expenditures.
But should either Yahoo or Google report their revenues in a different way? The proper method for revenue reporting depends on whether the company is merely an “agent” facilitating a deal, or a “principal” that stands to lose money (e.g. if an advertiser fails to pay). Yahoo claims that they are the primary obligor in their advertising transactions, which would, if true, give credence to their choice of model. However, as we saw in the Priceline.com case, the gross model was used even though the guidelines provided said that they should not. The reason for such a choice seems obvious: to obfuscate the performance of the company.
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Obfuscation in account records is fairly commonplace: the case with DuPont brought operating cash flow reporting to light. The use of the indirect method allows the company to bury the components of their day-to-day business deeper within their 10-Q and 10-K filings.
It’s hard to say if that is the case with Yahoo. Without knowing the intimate details of the contracts Yahoo has with their publishers and advertisers, it is hard to say whether or not they meet the criteria related to the gross method. The fact that Yahoo stresses its net revenues to investors denotes awareness that their gross income is not reliable as an indicator of success.
An indication that Yahoo correctly uses the gross revenue method is their dominance over Google in terms of net revenue. This is largely due to Google reevaluating the value of stock options, which lowered their net income. However, even a comparison of Google and Yahoo based on free-cash flow favors Yahoo.
How is one to make sense of this battle between Yahoo and Google? A few years have passed since this article was written, so we can check today’s press to see how this fight has played out. When one searches for “Google vs.” in today’s news, Bing is more likely to come up than Yahoo. Google’s stock is valued at close to $600, while Yahoo’s is at $16. Google has continuously developed new web tools and products, and is now effectively in a two-horse race with Microsoft to control web advertising. Meanwhile, Yahoo looks like it will be sold to AOL shortly.