TWST: One of your key investment theses is that social media is going to have a much bigger impact across the Internet media and e-commerce sectors than is currently believed on Wall Street. Would you elaborate on that? And specifically, what do you think others on Wall Street are missing or discounting?

Mr. Kerner: I think what we're seeing is Facebook is really emerging as the second Internet, a kind of social layer that is going to overlay on basically the entire Internet. So I think a good analogy to think of it is like we think of broadband today, in that you can go on the Internet using narrow band, but you just have a better experience if you go on broadband. And the only people who don't use broadband are the people who don't have access or can't afford it. And so to the degree that people have access to Facebook and because it's free, we think that Facebook is going to near ubiquity in terms of its adoption by people, as well as by Internet sites that want to leverage the Facebook social layer.

TWST: What do you think is the consensus view on how that ubiquity is going to impact more established Internet companies that had been dominant in the past?

Mr. Kerner: I think the most important thing to realize about the social layer is that it's going to broadly benefit the Internet in total. As a result of the social layer, advertising and e-commerce are both going to become more efficient online. And as a result, you are going to see an acceleration in the migration of both advertising and commerce from offline to online. And in the near term, that accelerated migration will broadly benefit those companies that derive the majority of their revenue online. As the online pie gets bigger, their share of the pie might shrink, but most of the major players are going to net-net be better off.

TWST: Do you believe the management teams of Internet media and e-commerce companies have a good understanding of the issue? What are they doing to get into the social media game or reduce negative impact on their companies?

Mr. Kerner: Certainly everybody is integrating with Facebook and deploying the Facebook Connect button on their Web sites, even MySpace, and they all want access to the information available in the social graph. Microsoft's (MSFT) Bing, with its partnership with Facebook, is already leveraging the "like" button information into its search results, and so that's a good example of how the social graph is being leveraged for search today. We also see a lot of other Web sites, like Urban Outfitters (URBN) or Levi's, that let you search on their sites through what people have liked or through what your friends have liked.

TWST: You have an "underperform" rating on Yahoo! Would you tell us some of the key risks and challenges for the company right now?

Mr. Kerner: To the degree Yahoo! (YHOO) is going to be driving the majority of its revenue going forward from display advertising, I think that they are going to benefit from the increased migration of offline advertising to online. But the question is to the degree that their audience isn't growing, they are at risk to lose share of the online advertising share that they currently have.

TWST: Is there anything you think they have in the works that could mitigate that or turn it around?

Mr. Kerner: They have some properties that have performed well. Most notably Shine, which is a women's property that they own. Yahoo! Answers, which is now their second biggest property after Yahoo! Mail, is still growing. Yahoo! Sports is also doing well. So they do have a number of properties that are growing the visitors and the visits per visitor; those are two of the metrics that we track. But other properties like Mail are suffering both from strong competition from the likes of Gmail, as well as from Facebook, as users are using that platform to communicate things they used to use Yahoo! Mail for. So they are using e-mail less. To the degree that people are getting their news from social media, that's impacting traffic to Yahoo! News. But Yahoo! recognizes the opportunity in social media and has a number of initiatives underway, including the Yahoo! Contributor Network, which is going to leverage the rise of citizen journalism. They have a partnership with Zynga to leverage the growth in social gaming. And they just announced Local Offers, which aggregates the offers from a number of deal sites like Groupon. So Yahoo! has a lot in the works that could help turn things around.

TWST: What are your thoughts on the impact of people increasingly using smartphones for Internet and e-mail, where you may not see advertising?

Mr. Kerner: The only secular trend larger than social media is mobile. Mobile search is going to be huge. We think location is going to be a large advertising medium. Only about 4% of people use location-based services today, but we think over time that number is going to grow meaningfully. So to the degree smartphones help us stay even more connected, that creates huge opportunities for Yahoo!

TWST: You had increased your price target for Yahoo! based on your improved valuation of Alibaba's assets. Would you tell us more about that?

Mr. Kerner: China is the world's largest Internet market, and it's growing rapidly. Yahoo! has a 40% interest in Alibaba (1688), whose assets include Taobao, the eBay (EBAY) of China, and Alipay, the PayPal of China, and Koubei, the Craigslist of China, and publicly-traded Alibaba.com, the leading e-commerce platform for Chinese exporters. It's a tremendously valuable group of assets, but it's also challenging to value, as the majority of the assets are private. We looked at public Chinese comps and took a 35% private market discount to arrive at our value of about $4 per Yahoo! share. We believe there is significant upside to that value over time, but we also believe unlocking that value is going to be difficult in the near term, given they're private, and Yahoo! has a low tax basis, so they have some work to do if they want to maximize value tax efficiently. The relationship is a little bit rocky now between Alibaba and Yahoo!, but Alibaba represents a great opportunity for Yahoo! to participate in the upside of the China market.

TWST: You upgraded Google to "neutral" last month. What factors contributed to that upgrade? And when you compare Google and Yahoo!, where does Google excel?

Mr. Kerner: Google (GOOG) is continuing to dominate the online search marketplace. The largest advertising medium on the Internet is search, and it continues to grow at a faster rate than display advertising is growing. When we first initiated on Google, we thought that Google would be headwinds from social media and the rise of Facebook. However, what we've seen is that social media is driving people to spend more time online, and that is actually leading to more Google searches. So rather than being a threat near term, Facebook is actually enhancing the already very strong tailwinds for Google, both in search and in display. We are also increasingly bullish on the monetization opportunities for Android. We believe Android's going to be the dominant global mobile platform and a very meaningful revenue contributor in the future. We also believe YouTube is very well positioned to benefit from the growth of online video advertising. So we believe that investor concern that Google is a one-trick pony will diminish over time, as we see multiple legs to the Google growth story going forward.

TWST: In your most recent Google report, you wrote that the company has the opportunity to string together some of its properties like YouTube and Blogspot to provide a social media experience that could be different from Facebook. What could that look like and how realistic is it? What catalyst would there need to be for that to happen?

Mr. Kerner: When the social graph concept was first introduced, people thought of the social graph as how people are connected to each other. But it's much bigger than that. It's also all of the information about what we do and what we like. Facebook certainly looks like it's going to be the biggest repository of that data, and so you not only know who your friends are in Facebook, but everything that you like on Facebook - the interests that you've highlighted on Facebook, the groups that you've joined on Facebook, the deals that you've participated on Facebook - so it's going to be a massive treasure trove of data in the social graph. But there's also going to be a lot of social graph data that's enabled by different Google properties. Gmail is obviously by its nature a very social experience. YouTube is an increasingly social experience. Blogger is a very social experience, and search is potentially going to become more social.

Google also just introduced Boutiques.com, which creates significant social graph data about the fashion you love or hate. So Google creates a tremendous amount of social graph data, and has access to mountains of other data through Twitter and others. So Google is also well positioned to create a very powerful social graph. We believe that search over time is going to be a blend of the algorithmic search Google already excels at with the social graph data that we've discussed. So we believe that Google remains very well positioned to give its users an increasingly compelling search experience.

TWST: Yahoo! management has said that page views are not a really good indicator of audience or engagement. In an ideal world, what metrics would you have access to in order to evaluate companies like Yahoo! and Google?

Mr. Kerner: We agree that page views is just one measure of engagement, but as it's the only aggregate engagement metric Yahoo! releases at the moment, we continue to give weight in our assessment of their progress. We also look at visitors, and visits per visitor as they're tracked by third-party providers. We look forward to Yahoo! discussing other engagement data points in the future. To the degree that Yahoo! is becoming more social, metrics like how many comments people are making and how much people are forwarding and sharing content, are other engagement metrics. So there are lots of other measures of engagement that Yahoo! can provide over time.

TWST: Is Google better able to provide more insight as far as those metrics are concerned?

Mr. Kerner: Google does provide information about the growth rates of total searches as well as the revenue per search, which are the key metrics to understand the growth in search revenue for Google. Display has a different set of metrics. We appreciate Yahoo!'s ability to create very engaging and very beautiful ads that they can sell for a lot of money. So even if they have lower page views, they might be able to monetize their remaining page views at higher rates because of their ability to give advertisers what Yahoo! refers to as "art." And art is important. Brands like to associate themselves with beautiful advertising, and Yahoo! is able to do that. Brands also like to behaviorally target their ads and reach the audience that they want to reach. And Yahoo! is also very strong at the science part of money to advertising.

TWST: Considering the impact of social media, what is your overall advice to investors in the Internet space generally at this point?

Mr. Kerner: I think investors should have broad exposure to the Internet, both in Internet advertising side and on e-commerce, and particularly those companies that are really kind of leveraging social media. Amazon (AMZN), I think, is doing a great job of leveraging social media. They've integrated with Facebook Connect on their own Web site, and they are starting to sell products on Facebook pages. Travelzoo (TZOO) is a company we like a lot that's now providing local deals. It's not just Internet companies that can leverage social media, it's any company that does a lot of marketing. Verizon (VZ), Coke (KO) and Kraft (KFT) are other companies that have really leveraged Facebook and Twitter to get their message out and build a following. We are seeing a lot of companies engaging and moving more ad dollars from offline to online, to engage with social media. And to do that, they are also buying more display advertising and more search advertising as well. The shift from offline to online in both advertising and commerce is a phenomena that is re-accelerating as a result of the secular trends of mobile and social, and investors should have broad exposure to those trends.

TWST: Thank you. (MES)

Note: Opinions and recommendations are as of 11/09/10.

Lou Kerner

Analyst

Wedbush Securities

1000 Wilshire Blvd.

Los Angeles, CA 90017

(213) 688-8000

www.wedbush.com