Yahoo (YHOO) Turnaround, Step 2: Layoffs?*


We hate to be the bearers of unpleasant news, but we expect that you’re going to hear it from someone else eventually, so it might as well be us.  Yahoo may have to lay off about 1,200 people.

The Problem: Several years of recovery from the Bubble 1.0 crash and a rocketing stock price made Yahoo fat, especially in the U.S.  The Google juggernaut, meanwhile, gobbled up much of Yahoo’s market share, leading to a sharp revenue deceleration.  The combination of these factors has pummelled the company’s operating margin.

Specifically, in the last four quarters, Yahoo’s adjusted operating margin (ex stock comp) has dropped from a respectable 30% to a gimpy 26% (yes, it could be much worse, but Yahoo fans deserve greatness).  Now that Yahoo has stabilised its management team (sort of) and put up a solid quarter, it’s time to fix the margin. 

The Numbers: We expect Yahoo’s margin will rise in Q4, on strong seasonal revenue, but it rose last year, too (to 32%), so that won’t get Yahoo off the hook.  We think Yahoo should get its margin back at least to where it was in the September quarter last year–30%–which will require about $240 million in annual cost cuts.  Most of these cuts should be made in the U.S., because it is the U.S. operating margin that has deteriorated.  (For details, please see this spreadsheet, published by SAI Research.)

The Solution: Yahoo could achieve these cuts immediately by cutting $120 million of non-human-expenses and laying off about 1,200 people (assuming all-in comp costs of $100,000 per person).   We suspect that Jerry Yang is far too nice a guy to just up and fire 1,200 people, so we believe he will view this solution as a last resort.  Instead, we expect Jerry will try to grow his way out of the problem by increasing revenue faster than costs. And assuming the top line comes in as expected, Yahoo may, in fact, be able to avoid painful layoffs.  (Again, please see this spreadsheet for details.)

Barbarians at the Gate: That said, at risk of sounding like Neutron Jack, we would recommend that Jerry at least consider taking the hit all at once.  Why? First, because he can–and should–blame it on Terry.  Second, because even a 1,200 person layoff would be less than a 10% reduction, and we have to believe that at least one in 10 Yahoo employees have essentially retired on the job.  Great companies like GE and Goldman Sachs drop their weakest 5% of staff each year, and this wouldn’t be much more of a cut.  (This practice helps improve morale, by the way: the remaining 90%+ of workhorses at Yahoo will be impressed and strengthened by it).

Third, such a cost cut would immediately boost Yahoo’s operating profit by more than 10%, and would probably trigger an even greater jump in the stock price (Why? Because investors would see that Jerry has the balls to make unpleasant decisions and has their best interests at heart).  The higher stock price would benefit almost everyone, including the company (stronger currency), current employees (more in-the-money options), and  employees who were laid off.  And, yes, it would also benefit us (Henry Blodget owns Yahoo shares).

*UPDATE: A Yahoo source who has been spot on in the past says that revenue trends (especially search) are strong enough that layoffs may not be necessary.

See Also:
SAI Research Spreadsheet: analysing Yahoo’s Potential Cost Cuts
Yahoo Q3: Stronger Than Expected
SAI Research Spreadsheet: Yahoo Key Metrics