The Yahoo!-Tumblr Deal Looks Too Cheap

 | May 21, 2013 | 7:00 AM EDT
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The carping on Wall Street on Monday was that Yahoo! (YHOO) is overpaying in its acquisition of Tumblr. The purchase price for the blogging and social-media site, which was started in 2007 by David Karp, who is an ancient 26 now, is $1.1 billion in cash. Tumblr, among the 20 most visited websites in the U.S., hosts about 100 million blogs and projects $100 million in revenue for 2013.

Frankly, I've got trouble with the math too. But not because Yahoo! is overpaying. I think it is yet another negative indicator for the Internet sector as a whole that the price is so low.

Yahoo! defended the deal in a conference call on Monday morning, saying that adding Tumblr would accelerate growth in Yahoo!'s core business. Tumblr's huge amount of user-generated (read that as "free") content with 5 billion original content posts will draw a lot of traffic and increase engagement with Yahoo!'s news sites, Yahoo! CEO Marissa Mayer told the conference call. Tumblr might also draw a younger audience to Yahoo!, which is now trying to find ways to add to its slow-growing email and search businesses.

You've got good reason to be skeptical about this hookup. After all, Yahoo! has stumbled in social media before, closing the social calendar site Upcoming and selling the social tagging service Delicious. Mayer acknowledged that track record when she promised not to screw it up.

But what's most troubling to me about this deal is how little Yahoo! is paying. The last round of venture capital Tumblr raised back in September 2011 valued the company at $800 million. A 25% step-up in 20 months isn't exactly the kind of exit that sets venture investors' hearts tingling.

So why so cheap?

Doubts are arising, yet again, about Internet advertising. Tumblr began to add advertising only last year, so this isn't a company that has an established ad strategy. And some Wall Street analysts have already expressed worries about Yahoo!'s ability to significantly increase ad revenue from what is now effectively an ad-free site.

Mayer implicitly acknowledged those doubts when she said on the conference call that Yahoo! would begin with a light ad load on Tumblr. (She didn't say, "in order not to alienate the Tumblr user," but she might as well have.) Yahoo! could work with bloggers who want to add advertising to their blogs, in an effort to increase their own revenue from blogging. Advertising would be done with the bloggers' approval.

To me, all this speaks to the big potential vulnerability for the Internet sector, from Google (GOOG) to Yahoo!. Exactly what is the selling price for an Internet ad, now that mobile has replaced the desktop as the fastest-growing type of access, and now that social media has started to eat away at such former strategies as portals and search?

Yahoo!'s acquisition of Tumblr doesn't answer those questions. It just makes sure that Yahoo! will be around while the sector works toward an answer.

The price of staying in the game was $1.1 billion. Cheap, when the alternative is irrelevance.

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