How Bad Could Mortgage Mess Get for GOOG, YHOO, RATE, et al

We believe most analysts are severely underestimating the impact the mortgage collapse could have on online advertising spending.  The same trends that are hurting mortgage companies will likely weaken spending by other financial services and housing-market-related companies--and the financial-services sector alone accounts for one-third of U.S. online advertising.  This bodes poorly for the revenue performance and stocks of Google (GOOG), Yahoo (YHOO), AOL (TW), Bankrate (RATE), and other ad-driven companies.

Yesterday, Peter Kafka laid out the bullish case for the mortgage-impact-on-online-ads and then explained why we take a more bearish view.  In this follow-up analysis, we run the actual numbers.  Here are the key points we think the bulls are missing:

1. The factors hurting mortgage companies will affect more than just the mortgage sector, especially other financial services companies.
2. Financial services alone accounts for about one-third of U.S. online ad spending.

We have run five scenarios  (conservative to aggressive), which we explain in detail after the jump.  Using the "base" scenario (middle case) and actual Q2 revenue for the "Big Four" (Google, Yahoo, AOL, and Microsoft), here is the summary conclusion: 

Assuming full impact of the mortgage crisis but no other economic spillover, we estimate that Q2 "Big Four" revenue would have been 5% lower (19% growth vs. 26%).  Assuming reasonable economic spillover, we estimate that revenue would have been 13% lower (9% growth).  This impact would be enough to cause the leading companies to miss numbers in Q4.

U.S. Internet Advertising Revenue    Q206A    Q207A    Y/Y                                                   
Total Actual "Big Four"                        $3,349    $4,212    26%                                                       

With Est. Mortgage Impact Alone (Base)             $3,997    19%
With Est. Total Economic Impact (Base)              $3,654    9%                                                       

This page lays out the actual year-over-year growth for the Big Four and our five scenarios for the potential mortgage impact on online advertising.  We first estimate the impact of the mortgage collapse alone.  Then we estimate possible additional impact from an economic chain reaction.  We run five scenarios, from conservative to aggressive.

MORTGAGE IMPACT

For our "mortgage impact" analysis, we make the following assumptions:

1. Financial services percentage of U.S. online ads (34%, per July Nielsen estimate of impressions)
2. Mortgage sector percent of financial services spending (20% to 40% range, 30% base)
3. Mortgage sector spending reduction after collapse (-30% to -70%, -50% base)

We conclude that a fall-off in mortgage sector spending alone could shrink Q2 run-rate online advertising spending by -2% to -10% (-5% base).

OTHER ECONOMIC IMPACT

As Peter Kafka explained yesterday, the mortgage sector is not a hermetically sealed corner of the financial services industry.  The crisis has already hit the performance and stocks of investment banks, private-equity firms, and other financial services companies.  A declining housing market, moreover, is putting pressure on REITs, real-estate agents, appraisal firms, contractors, home-supply companies, movers, and other industries, some of which will likely reduce online ad spending accordingly.

Our "economic spillover" analysis makes the following additional assumptions:

1. Percent reduction in "non-mortgage" financial services spending (-5% to -25%, -15% base)
2. Percent reduction in non-financial online ad spending (-2% to -20%, -6% base)

We conclude that the mortgage collapse plus a reasonable economic spillover could reduce run-rate U.S. online advertising spending by  -5% to -23% (-13% base). 

IMPORTANT NOTE

This analysis makes assumptions about only U.S. online advertising revenue.  Google's U.S. revenue now accounts for only one-half of its business.  Please feel free to weigh in with thoughts: hblodget@alleyinsider.com.