But Wait. Didn’t Yahoo Try a Deal Like This Before?

Source: Tumblr.com

When Yahoo announced its headline-grabbing acquisition, it boasted that the deal gave it access to an "unduplicated" audience of users and that its target was a "popular personal publishing" platform.

"Yahoo will be able to integrate and distribute a powerful set of state-of-the-art editing tools and content published through personal home pages in an array of services," the company declared.

But Yahoo wasn't talking about Tumblr. Those quotes came from a news release Yahoo issued in 1999 when it acquired GeoCities, which allowed users to create their own Web pages — not unlike Tumblr — for $3.6 billion in stock. The site was closed in 2009.

As investors and analysts size up Yahoo's latest $1.1 billion acquisition, it is worth reflecting on the GeoCities deal, which has many similarities. Both companies were money losers when they agreed to be acquired. Tumblr had just $13 million in revenue last year, according to reports.

Both companies had loyal followers that quickly left in droves. According to Matt Mullenweg, the founder of WordPress and a competitor, Tumblr users were moving their posts over to WordPress at a rate of 72,000 an hour amid speculation of an impending deal this weekend. (Usually, he said, Tumblr users migrated 400 to 600 posts an hour). Still, for perspective, Tumblr users generate tens of millions of posts a day.

And GeoCities and Tumblr had at one point been averse to accepting advertising. Tumblr's 26-year-old chief executive (and now multimillionaire), David Karp, said three years ago, "We're pretty opposed to advertising," adding that "It turns our stomach."

The lesson of GeoCities raises this question about Tumblr: How can a company with zero profits (actually, multimillion-dollar losses) and just $13 million in revenue be worth $1.1 billion?

Inside Yahoo, officials dismiss the comparison to GeoCities. Instead, they compare the Tumblr deal to Google's purchase of YouTube — that is, Yahoo's management believes that Tumblr is one of a rare few transformative sites on the Internet. Google paid $1.6 billion for YouTube when it too made no money. At the time of that deal, it seemed heretical. Now, it seems genius.

To Yahoo, Tumblr is the equivalent of beachfront property. With more than 100 million user-generated blogs on Tumblr, there is no question that it brings Yahoo a younger audience. It adds a sense of hipness to a company that had lost its sense of cool.

According to Marissa Mayer, Yahoo's chief executive, who drove this deal, Tumblr brings Yahoo a possible growth engine for the future.

But that's a big if. It requires Ms. Mayer's team to execute brilliantly and online users to continue to want to establish ways to communicate outside of places like Facebook and Twitter.

And then there is the pesky issue of selling ads on Tumblr's pages without upsetting the site's finicky users. (One user began a petition to block the deal.)

"It is difficult to justify the premium acquisition price for Tumblr given its low levels of revenue," wrote Doug Anmuth of Barclays Capital in a note to investors. "In addition, we believe Yahoo needs to be careful about the manner in which it monetizes Tumblr, as a significant ad load and the perception of a large corporate owner could potentially alienate Tumblr's core user base. Though we believe Tumblr's model does have switching costs for users, we do not view its actual barriers to entry as particularly high."

If you want to do the math on what it would take for Yahoo to justify the price tag, Brian Pitz, an analyst at Jefferies, has sketched it out. By his count, Yahoo will need to figure out a way to make $127 million a year in profit from Tumblr, meaning the site would have to bring in an additional $950 million annually in advertising revenue.

That's a big challenge, especially considering that Ms. Mayer pledged that while she planned to add more ads to Tumblr, she would do so mostly on the site's "dashboard" or newsfeed.

"We would like to look at them and understand how we could introduce ads — in a very light ad load — where the impact is really created, because the ads really fit the users' expectations and follow the form and function of the dashboard," Ms. Mayer said.

She said she might add advertising to user pages, but only with the permission of the blogger. That means a lot of Web pages will not be monetized.

And there is the issue of porn. Yes, porn. At least some of Tumblr's users post images that are not exactly "work safe." Indeed, Tumblr's own terms of service allows for such content. Such content could make Tumblr a challenging environment for advertisers.

More From the NYT:
The Tax Costs for Tumblr's Owners
Putting the Exclamation Point Back in Yahoo
Tumblr Deal Was a Private Party, With Few Bankers Invited

Tumblr's users also regularly post copyrighted images and other content Yahoo will have to find a way to police. When Tumblr was just an upstart, content owners were unlikely to pursue claims against the company, but now that it might be owned by a big public corporation, you can bet that copyright owners, some of whom compete with Yahoo, will be contacting their lawyers.

Given all of that, you might expect me to say that Yahoo should have never proposed acquiring Tumblr. But I won't.

It may actually turn out to be the right bet. The key is recognizing that it is a shoot-the-moon gamble. It might work out. It might not.

And even if it does not work out, analysts note that Yahoo can afford to experiment given the billions of dollars it has in cash.

As Jordan Rohan, an analyst at Stifel Nicolaus, wrote: "Even a squandering of $1.1 billion in cash, however unlikely that might seem to Yahoo management, would only move the sum-of-parts slightly."