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As the clock counts down on negotiations with AOL Time Warner, investors in Overture Services are struggling to guess the score.
The puzzle isn't simply whether Overture will renew its year-and-a-half-old agreement, which expires this month, for AOL to employ its pay-for-placement Internet search engine.
Rather, the uncertainty is the latest episode of an ongoing debate about whether Overture -- a fast-growing and profitable firm that sells advertisers prominent listings in its search engine -- has developed a defensible business model. The company and its supporters say Overture has developed a valuable moneymaker for Web sites that they can't easily develop on their own.
But short-sellers argue that Overture is at the mercy of its largest affiliates -- that is, the companies such as AOL that employ Overture's search engine on their Web sites. And, speculate the shorts, the upshot of negotiations with America Online -- perhaps with AOL getting a bigger cut of Overture's ad revenues, or perhaps with Overture getting dropped from AOL -- will reflect large affiliates' greater power.
Fighting the Power
In a striking example of the degree to which affiliation issues can affect Overture's stock, the company's shares fell more than 40% in early February, following news that EarthLink (ELNK:Nasdaq - news - commentary - research - analysis) was discontinuing its partnership with Overture in favor of a new agreement with Overture's rival, the privately held Google.
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Shares in Overture have fallen in recent days, a victim of uncertainty over the AOL extension. On Monday, shares in Overture rose 3% to close at $30. That closing price was down 14% from last week's high of $35.07, with much of the decline coming last Friday.
Overture Services CEO Ted Meisel, citing company policy, declined to comment Monday on both the state of negotiations with AOL and the effect of AOL-related speculation on the company's shares.
But, reiterating statements the company had made earlier, Meisel said, "We believe we have a good relationship with AOL," as evidenced by a three-year deal announced with AOL Europe earlier this year, covering the U.K., France and Germany.
An AOL spokeswoman declined to comment on negotiations between AOL and Overture.
All Over the Map
Overture shares in 2002
In an illustration of the clues that investors are seeking as to the nature of any contract extension, one short-seller inferred negative news for Overture from the company's adoption in early March of a shareholder rights or "poison pill" plan designed to prevent someone from buying a controlling stake in the company without paying a premium to shareholders. Overture said the measure was adopted as a prudent corporate governance measure, not in response to any specific takeover proposals.
The short-seller, speaking on condition of anonymity, speculated that Overture adopted the measure because it feared somebody might buy up the stock if its shares dropped. What would cause the shares to drop, said the short-seller, would be any announcement that AOL might not renew its agreement. Meisel declined comment on that scenario.
Though, as foreshadowed by the EarthLink episode, Overture shareholders appear to fear material damage from AOL's possible nonrenewal, the company doesn't. As Meisel repeated Monday, the company did not assume renewal of the AOL agreement when it issued guidance in February for full year 2002, nor did it assume extension of the company's affiliation agreement with Yahoo! (YHOO:Nasdaq - news - commentary - research - analysis) beyond its scheduled expiration at midyear.
So even without further contributions from AOL and Yahoo!, Overture expects revenue to rise 53% to $442 million in 2002 and net income to nearly triple to $58 million.
Distinction, Difference
An article published TheStreet.com in February drew a comparison between Overture and advertising representation firms in traditional media, raising the question whether Overture might, like those other companies, have to turn over a greater percentage of advertising dollars to its affiliates. Meisel on Monday drew a distinction between Overture and those rep firms.
Most advertising rep businesses work with "a couple hundred" advertisers, while Overture works with more than 50,000 advertisers, says Meisel. That implies a larger infrastructure and greater capital expenditure, and greater corresponding revenue retained at the firm. In addition, says Meisel, unlike ad reps, Overture doesn't simply sell ads but also has to ensure that its search listings are valuable to consumers, just like any other search engine. "It's a product, not a rep business," says Meisel.
Meisel says the company, which implemented a new set of rules in January to ensure the relevance of paid listings, is addressing problems that arose when the new guidelines were instituted. "We heard rules were too complicated, or weren't implemented as evenly as we would have liked," says Meisel. "We're all over that now, with simplifying the rules and additional training and support tools for our product quality team."
Not knowing AOL's inner workings, I am basically talking through my hat. But it just makes sense that a company the size of AOL would prefer to control their own purse strings.
Having "employed" Overture for some while and after having a good length of time to observe the pros and cons of PPC from the front row, I am sure they have had a team of "experts" working on an analysis of the project from stem to stern. They have likely analized it to death and pulled it apart several hundred times.
My guess is that if the in house team have decided its a workable scheme with a future lasting more than two years, they will do it themselves. If they feel it is dust in the wind and certain to die out, they will renew the contract until it is no longer viable and will pump Overture until it is dry.
At least, if I were in their shoes ... that's what I would do! :)
