February 7, 2002 2:35 PM PST

Overture bullish despite EarthLink loss

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Search company Overture Services said Thursday that it would "substantially exceed" Wall Street expectations for its fourth quarter, despite losing EarthLink as a client.

That outlook comes a day after Overture shares fell 41 percent on news that Internet service provider EarthLink had decided to use search engine Google. Because of EarthLink's shift, investors, who usually cheer the company, are now worried about increasing competition.

In a move to quell some of those worries, Overture said it would report its second straight profitable quarter when it posts fourth-quarter results next week. Overture had been projecting fourth-quarter revenue of $76 million and earnings of $10 million, or 17 cents per share, which it now says it will surpass "by a wide margin."

Analysts had been expecting the company to report a fourth-quarter profit of 19 cents per share on revenue of $84.9 million, according to First Call.

On Thursday, shares of Overture closed up $4.73, or 26 percent, at $22.65.

The company hosted a conference call to answer analysts' questions about its new competition and the company's outlook.

"We've been in a competitive market for years now, with more than 100 companies in the pay-for-performance" market, said Overture CEO Ted Weisel.

"Given the size and growth in this market, I would expect competition to continue. But I would assure you that we're not resting on our laurels...Any (company looking to enter this market) would have to invest over several years to match our service."

In or out of favor?
Overture, formerly known as GoTo.com, had been one of the rare Internet companies in Wall Street's good graces. The company reported an operating profit last fall, and its "pay-for-performance" business model, where advertisers pay to be listed in search engine results, was looked on favorably even at a time when Internet advertising was in the doldrums.

And in the past year, the company signed deals with Microsoft and Yahoo, establishing itself as a leader. Overture also counts America Online as a customer.

So what's the problem? All three of those deals come up for renewal in the next six months, said analysts, noting that Overture shares may be hampered until those deals are renewed.

Overture's deal with Yahoo has been extended to the end of the second quarter, the company said. According to regulatory filings, Overture's agreement with AOL Time Warner's online service expires in March, and its deal for placement in Microsoft's MSN portal runs out in June.

Overture said that losing the EarthLink deal would not have a material affect on its results. Analysts called Wednesday's sell-off overblown, saying Overture's business should be able to withstand the competition.

Indeed, analyst Lanny Baker at Salomon Smith Barney estimated that EarthLink accounts for only 2 percent to 3 percent of Overture's business. AOL and Microsoft, meanwhile, accounted for 40 percent to 50 percent of its third-quarter revenue. Additionally, AOL's European operations have already signed a multiyear deal.

The company's relationship with AOL appears to be locked for the coming year. Though Overture's $50 million deal with the online portal expires in March, an AOL representative said the relationship "continues to be a strong...and one that we expect to continue."

But Yahoo may be harder to pin down after its short-term partnership with Overture dissolves in June; the company has announced plans to create its own pay-for-performance service this year.

"Our relationship with Overture has been very satisfactory, (but) we're still evaluating the financial and strategic benefits of launching our own program," said a Yahoo representative.

Still, Overture has said that its financial outlook for the second half of 2002 factors in only one of the "big three" portals: MSN, Yahoo or AOL. The company is pinning its growth on an increase in the average price per click, additional pending deals and international expansion.

A small loss
Baker, writing in a research note, said although the "perception of competition" would likely hurt the company's stock in the near term, in the long term, "we expect the reality of Overture's strong business model to reassert itself."

Other analysts agreed. U.S. Bancorp Piper Jaffray analyst Safa Rashtchy said it is "highly misguided" to think Overture will lose its large customers because EarthLink decided to go with Google.

Rashtchy argued that EarthLink most likely chose Google because it wanted a brand name to build its search traffic, which is minimal. Meanwhile, Google is increasingly becoming a competitor of AOL, Yahoo and MSN; this may help Overture, viewed as more of a back-end player in search, renew contracts.

"The incremental encroachment by Google into paid-listings syndication does not change the outlook for Overture to maintain and renew its major agreements," Rashtchy said. "While Google provides outstanding algorithmically generated search results, we believe Overture offers the best paid-listings products for portals and advertisers."

Rashtchy said customers would stick with Overture as long as the company delivers strong revenue-per-search numbers. He estimates that Overture generates three times more revenue per search than Google.

The EarthLink deal may have fallen through because Overture was unwilling to lower prices to keep the business, said Goldman Sachs analyst Anthony Noto, who added that he saw that "as a positive and a sign that there were other business opportunities, and therefore it was not necessary to compete on price."

For its part, Overture seems confident about its prospects for 2002: The company increased its revenue projection of $345 million by more than 25 percent and raised its earnings projection of 45 cents per share by more than 75 percent, or as much as 79 cents per share.

First Call consensus for 2002 was for a profit of 49 cents per share.

 

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