Yahoo! Faces New Challenges After Tumblr Purchase

NEW YORK (TheStreet) -- Yahoo!'s decision to buy Tumblr for $1.1 billion signals a turning point for the aging Web pioneer.

Criticisms over the purchase are abundant, but when we consider Yahoo!'s possible motivation for the transaction it starts to become clear the company is looking to reposition itself as a more social media-friendly member of the tech space.

With the purchase, Yahoo! has committed to the biggest buyout of a social networking company in recent memory. As a point of perspective, Facebook's 2012 buyout of Instagram came in closer to the $1 billion mark.

Yahoo! recently installed Marissa Mayer as CEO and at this stage it looks as though the company is making an attempt to re-invent itself in a number of different ways. Yahoo! has made multiple deals since Meyer has taken the helm but, to date, this marks the biggest of the lot.

The acquisition of Tumblr means the company has turned its focus to social-media in an attempt to make up for its constant misses connecting with younger users.

Tumblr's blogs total 108 million, so its strong presence on the Web is undeniable. A much better question to ask, however, is whether or not Tumblr can turn a profit. With limited success in mobile devices, the six-year-old company has some clear challenges moving forward.

The mobile space is quickly becoming the central consumer gateway to browse the Web, and Yahoo! will need to find ways for Tumblr to maintain a commanding presence amongst smartphone and tablet users.

Monetizing social media applications (mobile or otherwise) is notoriously difficult, with well-documented examples to be found in FaceBook's failures with Instagram.

Generally speaking, these companies look to build product loyalty first and generate revenue later. But in many cases these revenue fail to materialize.

Comments from Yahoo!'s CFO Ken Goldman suggest that Tumblr will start boosting company profits as early as next year. But if we start to see evidence that these projections are unrealistic, Wall Street is unlikely to respond favorably, given Yahoo!'s prior tendency to overpay for startups and then fail to maximize their underlying potential.

Yahoo!'s past examples of squandered opportunities include its purchase of GeoCities (an early social networking site) for $3.6 billion and Flickr for $35 million. Many of Yahoo!'s startup acquisitions have been neglected or shut down completely, so it makes sense for Yahoo! to keep most of Tumblr's staff in order to maintain operations and avoid adding to the list of previous failures.

Such an expensive acquisition means that analysts will more highly scrutinize Yahoo!'s plans for Tumblr. It is already easy to argue that it was a mistake to buy a site that has largely failed to generate revenue. After selling half its stake in Alibaba, Yahoo! has $4.3 billion in extra cash to spend on building its core products (email, sports and financial news, and mobile services). So, from an investment perspective, Yahoo! will next need to make the case for how exactly Tumbr fits into this broader picture.

What's in it for Yahoo!?

As the 24th-most-visited site on the web, Tumblr gives Yahoo! a fully-developed social network with a significant following: According to Quantcast, Tumblr has 44 million users in the U.S., and 134 million users worldwide. But at 700 million, Yahoo! already has one of the largest user bases on the internet.

So it is more likely that Yahoo! sees Tumblr's value in driving its advertising operations -- an area where Yahoo! used to be the dominant player in U.S. markets.

According to eMarketer, Yahoo!'s market share in digital advertising dropped to 8.4% in 2012 (nearly half of what it was in 2009). Tumblr's large number of blog pages means increased ad space for Yahoo!, and new efforts by Tumblr to create interactive ad campaigns can help build on the traditional "point and click" model that is typically seen on Yahoo!'s pages.

But with Tumblr's actual performance falling well below its revenue goals, it is unclear how much of an asset Tumblr can actually be for its new parent company. Tumblr reported $13 million in revenue for the first quarter, after posting $13 million for all of 2012.

After spending an estimated $25 million in cash last year, Tumblr's true value to Yahoo! remains questionable at best. This means Yahoo! will face heightened scrutiny this year as investors look to assess the compatibility of these companies and their ability to improve on weaknesses seen in the past.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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