Earnings Outweigh Loss of Contract as Overture Climbs

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Earnings Outweigh Loss of Contract as Overture Climbs

Corporate Focus

by Anthony Palazzo

In jittery markets, investors shoot first and ask questions later. This appears to be the case with Overture Services Inc., the paid-search service whose stock fell into a tailspin two weeks ago, but somehow fired back.

By Feb. 14, the company had recovered all the ground lost since Feb. 5, when ISP EarthLink dumped Overture for another search provider, Google Inc.

Financially, the EarthLink deal is insignificant it was valued at $10 million and few use the ISP as a home page but it spooked investors mightily.

When markets opened Feb. 6, the stock fell as low as $17.61 per share, a 41 percent decline. Investors had reduced to 50 times Overture’s earnings from 80 times the amount they would pay for the stock, said Salomon Smith Barney analyst Lanny Baker. But a series of public-relations victories has succeeded in nursing the price back. On Feb. 14, the stock closed at $31.54.

“Things are really humming here,” said Jim Olson, an Overture spokesman. “We’re continuing to hire, there’s a great deal of energy and momentum happening here.”

After the EarthLink news broke, Overture hastily put together a conference call, where it reminded investors of previous upside guidance for the fourth quarter, and raised its targets for 2002. The company also extended through June a partnership with a larger customer, Yahoo Inc. The deal was previously set to end in March.

Results surpass expectations

From there, the good news just kept on coming. On Feb. 12, Overture announced a deal to provide search results to another big customer, Microsoft Corp.’s MSN unit, giving analysts an excuse to raise estimates for full-year 2002.

After markets closed that same day, Overture announced fourth quarter results that surpassed expectations by far, notwithstanding the earlier upside guidance.

Overture reported net income of $20.8 million (35 cents per diluted share) for the fourth quarter ended Dec. 31, compared with a loss of $361.7 million ($7.27) in the like year-earlier period.

Fourth-quarter revenue surged to $101.2 million, vs. $39.8 million in the fourth quarter of 2000.

Overture’s balance sheet is pristine. It carries no debt, no inventory and $170 million in cash, or $2.90 per share, according to Merrill Lynch analyst Justin Baldauf.

So why did the stock break down, and then recover, so quickly? Because implicit in its lofty price was the idea among investors that Overture had no competition, said Baker.

When Google won the EarthLink relationship, investors first realized that the non-competition story was a myth, Baker said. With the Yahoo and MSN wins, they’ve reconsidered. “Maybe there is competition, but you know what? The competition is getting drubbed.”

Overture’s business model relies on a snowball-like dynamic between its advertisers and the Web sites where the search is placed. The more sites Overture is on, the more attractive it is to advertisers, who want to reach as many customers as possible. The more advertisers included in Overture’s search results, the more attractive it is to Web sites considering using it. They’re looking to serve up as many revenue-producing clicks to their readers as possible.

Overture auctions search result placement to advertisers willing to pay to be the first link to appear as a result of a search.

Earnings estimate raised

Olson wouldn’t talk specifically about the stock movement, but he acknowledged that the announcements were designed to buck up stakeholders, including advertisers. “All these things sort of collectively are designed to communicate all this great news,” he said.

In light of the MSN deal, which lasts through 2003, Baldauf raised his full-year 2002 earnings estimate to 93 cents per share from 79 cents. (Full-year 2001 earnings were $20.1 million, or 36 cents per share.) He also projected 2002 revenues of $443 million, up from $288 million in 2001 and a previous 2002 estimate of $432 million.

There are two huge renewal deals looming for Overture, and these likely will set likely set the tone for the stock’s trading patterns through the rest of the year.

One is a distribution agreement with AOL Time Warner Inc. unit AOL, which is set to expire at the end of March, and the other is a further extension of the Yahoo deal.

Baldauf believes that the AOL deal will be renewed, notwithstanding Overture’s recent agreement with Microsoft, AOL’s archrival. The Yahoo deal is less likely, he said in a Feb. 13 report, because Yahoo wants to create an in-house version of the Overture service. But in the end, Baldauf said, he expects Yahoo to extend again. The deal is producing good results for Yahoo, he said, and it will be difficult to recreate the same thing on its own, partly because Overture owns the patents on its auction process.

Indeed, Baldauf said, “The decision by Microsoft, the world’s leading software developer, to use Overture rather than go it alone may in part reflect this realization.”

Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224, or at

[email protected].

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