(FORTUNE Magazine) – John Corcoran loves Yahoo. Using a broadband connection at his office in Boston, the 39-year-old Internet analyst relies on the popular portal to follow breaking news, track company information, and take the pulse of investor sentiment by visiting chat rooms. "I use Yahoo literally ten times a day," Corcoran says. "It's an outstanding service." When the World Trade Center attack briefly took out his corporate e-mail, he turned to Yahoo mail. "It works really well," he reports.

But Corcoran, who follows Yahoo for CIBC World Markets, can't muster nearly as much enthusiasm for Yahoo's stock. That's partly because of his own experience. He ignores banner ads, he doesn't pay for any of Yahoo's services, and he has never bought anything from its shopping mall or travel channel. "Other than advertising," he says, "they've generated the sum total of zero revenue from me." More important, he says, Yahoo's financials don't add up. Profits have all but evaporated, even by the company's own generous accounting standards. Revenues are way down too. The stock price, of course, has collapsed, yet even with shares trading at just $12--down from a peak of $237 in January 2000--Yahoo remains "richly valued," Corcoran says. The market values Yahoo at about $5.2 billion, more than seven times current-year revenues, and Yahoo shares carry a price/2001-earnings ratio of about 200 to one.

"Yahoo is a growth story that has stopped growing," Corcoran says. Like more than half of the 25 analysts who cover Yahoo, he has a hold on the stock. Roughly translated, that means "beware of dog."

Yahoo's plight illustrates how dramatically the world has changed in little more than a year's time. A onetime darling of Silicon Valley and Wall Street, Yahoo has been hit by a triple whammy: the collapse of the dot-com bubble, a severely depressed advertising market, and the widespread economic uncertainties brought on by the Sept. 11 terrorist attacks. Yahoo still has a great brand, a great product, and a vast worldwide audience. But because 80% of its revenues come from Internet advertising, an unproven business even now, Yahoo's future looks shaky. And the company faces two intimidating competitors in Microsoft and AOL Time Warner (the parent of FORTUNE's publisher).

At the very least, you have to admire Terry Semel, who became chairman and CEO of Yahoo in May, for taking on a tough job. Semel didn't need the gig. He'd run the Warner Bros. movie and television studio for nearly 20 years with his partner, Bob Daly, building the business and becoming a rich man. In fact, just before signing on at Yahoo, he put his own money on the line by buying one million shares of Yahoo, at $17.62 a share; he has lost about $6.5 million on paper since then. He's not disheartened. While Semel declined to sit for an interview with FORTUNE, he says via e-mail that he's more confident than ever that given time--real time, not Internet time--Yahoo will flourish. "We are the Internet's dominant brand," he says. "We have the largest and most loyal audience. When advertising spending picks up, Yahoo will be well positioned to take a disproportionate share of the market."

Semel's turnaround plan, such as it is, reflects his belief that the company is fundamentally okay. He's taking a cautious, incremental approach: Reach out to advertisers. Cultivate big corporate clients. Try to sell premium services to users. Cut costs. And counsel patience. "No single event will transform this company," says the 58-year-old Semel. He brushes off all speculation that Yahoo is being dressed up for a sale and says a step-by-step approach is what's needed: "My theme continues to be evolution, not revolution." Not revolution? Alas, like Internet revenues, profits, and share prices, Internet rhetoric has become a mere shadow of its former self.

The good news for Yahoo is that the portal remains a big hit with Internet users. While measuring online audiences is an imprecise art, Yahoo reports that about 210 million users log on to its properties each month, that 80 million of them have registered and shared their personal information, and that 37 million use it as their home page. Those are all impressive numbers by any media-industry standard. Users keep coming back because Yahoo delivers lots of rich content and useful features like e-mail, messaging, and chat. Even skeptics say that the people at Yahoo have done a good job of serving their audience and managing their operations. "They've executed extremely well," says Rob Martin, an Internet analyst with Friedman Billings Ramsey & Co., who nevertheless rates the stock only a "market perform."

But success came so easily during the dot-com boom that Yahoo developed bad habits and made bad choices. Because revenues flowed freely, especially from Internet startups, Yahoo's advertising sales force grew arrogant, mistreating even important customers. Because profits didn't seem to matter, Yahoo pampered its users by giving away valuable services. Because its stock price seemed to know no direction but up, Yahoo chose not to strike a deal with a traditional media partner, as AOL did with Time Warner, or to diversify its revenues by merging with eBay, a deal that was seriously considered last year. So when hard times arrived, Yahoo was unprepared.

Now that they are here, the business has turned ugly. This year, even if the company reaches its reduced financial targets, revenues will be off by more than 35%. What Yahoo describes as "pro forma net earnings" will decline by 90%, and under Generally Accepted Accounting Principles, Yahoo won't earn anything at all. To claim a penny-per-share profit in the third quarter, Yahoo asked analysts to ignore "acquisition-related and restructuring charges, amortization of intangibles and stock compensation, employer payroll taxes on gains realized by employees from nonqualified stock option exercises, investment gains and losses, and income related to a contract termination fee." If you choose not to ignore those things, Yahoo lost $24 million in the quarter, and it has lost $84 million during the first nine months of the year. Only a small portion of the losses, about $3 million or so, was attributed to increased costs and canceled ads following the Sept. 11 terrorist attacks.

Last spring Yahoo moved into brand-new, 800,000-square-foot headquarters on a campus in Sunnyvale, Calif., that was designed during the dot-com boom. It's a very cool place, with an airy, glass-walled cafeteria, a big gym packed with exercise equipment, and plenty of lawn space along San Francisco Bay, where after work people can play volleyball or attend occasional company-sponsored rock concerts.

When FORTUNE visited Yahoo a few days after the attacks, the place was humming. Naturally everyone at Yahoo was saddened by what had happened in New York City and Washington, but rather than despairing, people were finding ways to help. Srinija Srinivasan, Yahoo's editor-in-chief, its fifth employee, and a friend of co-founders David Filo and Jerry Yang, had just heard that survivors of the attacks used Yahoo Messenger and e-mail to tell family and friends that they were still alive. "That blows my mind," she says. "To feel we can do some small thing really helps at a time like this." The company hosted the American Red Cross' Website as it became overwhelmed with traffic, and within a week had helped the Red Cross raise $20 million online. That compares with $2.4 million in online donations for all of last year. Later Semel says, "That's when you know you're part of something really big."

Yahoo has always had a mission that goes beyond the bottom line. Created by Stanford students Filo and Yang in 1994 as a Web directory, Yahoo, which originally stood for Yet Another Hierarchical Officious Oracle, was built to guide people through the sprawling Internet. It's gone way beyond that since then, of course, while remaining resolutely user-friendly, thanks largely to its co-founders, known as the "chief Yahoos." Yahoo has not, for example, sold its search listings to advertisers, as other portals have, preferring to keep them pure, nor will it permit pop-up or pop-under ads on its home page that would slow down or disrupt the customer experience. While that stance has frustrated some advertisers, it's built into Yahoo's DNA. "If we are doggedly, tirelessly, passionately user-focused, that will pay off," Srinivasan says.

It has already helped Yahoo become one of the three victors in the portal wars. While Disney's Go and NBC's Snap have folded, Excite has gone bankrupt, and Lycos has faded, AOL, Microsoft, and Yahoo have emerged as the Big Three of the Internet, in that order, according to Jupiter Media Metrix's U.S. numbers for September. On a global basis, Yahoo argues that it's the No. 1 portal. Regardless, Semel says, "there are three major worldwide portals, and we don't see a fourth. And therein lies the opportunity. We have a global franchise that simply cannot be replicated."

To turn that franchise into a growth business again, Semel and his management team are focusing on three daunting tasks. First, they are trying to persuade Yahoo's loyal users to pay for new offerings and for services that used to be free. Second, they are trying to sell products and services to corporations. Finally, and most important, they are going all-out to get traditional marketers to spend more on Internet advertising. What all three projects have in common is that they require people to change entrenched habits, which is never easy.

Let's start with job No. 1: persuading users to spend money with Yahoo. The company has erected for-sale signs all over its site, asking users to buy extra home-page space, personal domain names, enhanced e-mail, added bandwidth, in-depth financial research, real-time stock quotes, auction listings, online bill paying, even photo developing. Mostly they are priced a la carte; personal ads, for example, cost nothing to post but replying to them requires a payment of $19.95 a month. Yahoo won't say how many people have signed up for any of the services, in part because most are very new. But even insiders concede it won't be easy to turn Internet users who are accustomed to freebies into paying customers. "We have absolutely trained people to get things for free," says Geoff Ralston, vice president of Yahoo communications.

Second, Yahoo has been working to expand several lines of business aimed at corporations. Since buying an Internet startup called Broadcast.com for $5.7 billion back in 1999, Yahoo has offered Web conferences, online training, and virtual corporate meetings, all of which could have greater appeal as companies cut back on travel. The Broadcast Yahoo division also built a streaming-media site for Purina at which dog and cat lovers can watch videos about training, behavior, health, and nutrition. Another unit, called Corporate Yahoo, builds and services Websites for companies and other entities, among them McDonald's, Pfizer, and the state of North Carolina. The difficulty with these businesses is that they are very competitive and generate lower margins than advertising sales. So far only 32 corporations have hired Corporate Yahoo. "Corporate portal services are not where companies' heads are at this moment," says FBR analyst Martin.

That leaves Internet advertising, which almost everyone believes will become an enormous opportunity--someday. But it's a business that remains clouded by unknowns. No one, for example, can tell you with any certainty the size of the market today, let alone predict when, if ever, it will resume its once explosive growth. Estimates for 2001 range from $5.7 billion (Jupiter Media Metrix) to $6 billion (Forrester) to $6.9 billion (Merrill Lynch, which grew so frustrated with the inconsistency of third-party data that it decided to collect its own). FORTUNE interviewed buyers of interactive advertising at such major agencies as Starcom MediaVest, Ogilvy & Mather, Modem Media, Foote Cone & Belding, and TWBA/Chiat/Day, as well as outside experts, and no one--no one--expects the market to grow by more than 10% to 15% next year. That's bad news for Yahoo, which, remember, is still valued as a high-growth company.

If traditional marketers could be persuaded to shift more of their advertising online, growth could accelerate. But few expect that to happen anytime soon. "Traditional marketers aren't really convinced that online advertising works, and they don't really know how to do it well," says Jim Nail, a senior analyst with Forrester Research. "While they are spending money, it's still very slow and very tentative." If anything, the trend is moving in the wrong direction for Yahoo. As marketers have curbed spending on all advertising this year, they have tended to cut back further on Web media than on traditional outlets.

Maybe the biggest problem is that digital marketing remains frightfully complex. The category includes banner ads of all shapes and sizes, pop-ups, pop-unders, streaming media, e-mail marketing, the buying of search words, coupon offerings, and contests, among other options. Even for experienced buyers, the options are dizzying. "We're still learning to tie our shoes," laments Jonathan Adams, a senior partner at Ogilvy One. To further complicate things, online publishers lack a standard pricing model, charging for some ads based on how many people see them and for others based on how many click or buy. And Internet publishers are still struggling to exploit the great promise of online advertising: the ability to target ads and measure their effectiveness. "Both are in their absolute infancy," says Rishad Tobaccowala, executive vice president of Starcom MediaVest. "Unfortunately, they've been overhyped and oversold." Tobaccowala, one of the industry's most respected thinkers, expects Internet advertising to grow by just 5% or 6% next year.

As optimists like to say, every problem contains an opportunity. Yahoo says it's trying to address all of those issues, and Internet media buyers confirm that the company, in a dramatic turnaround, is jumping through hoops these days to please advertisers. Yahoo has cut its prices (not that it had any choice in a down market), become more flexible about the kinds of ads it will accept, and hired experienced sales executives with strong industry ties. "They're not the 22-year-olds acting cocky about their stock options anymore," says Andy Pakula, CEO of Orb Digital, a media buyer.

One turning point cited by many: an arresting commercial for the 2002 Ford Explorer that debuted on Yahoo in May, featuring a roaring engine, a shaking browser, and a full-sized picture of the new SUV that filled the screen of those who clicked. "They realized they needed to change, and they've changed," says Sharon Katz, director of media for Modem Media, a marketing consulting firm. It was the first time Yahoo had allowed an animated ad onto its home page, and Chief Yahoo Filo stayed up half the night to make sure that customers weren't inconvenienced.

To deepen its relationships with advertisers, Yahoo has begun to offer corporate customers access to research about online consumers, as well as the opportunity to collect millions of e-mail addresses that enable one-to-one marketing. "We are in many respects close to the perfect medium for research," says Greg Coleman, a senior Yahoo executive who came over from Reader's Digest. "We can do it better, cheaper, and faster." For a sense of what he's talking about, check out a Yahoo's Buzz Index at buzz.yahoo.com to see what topics, TV shows, movies, music, actors, and sports stars Yahoo users are searching for online. (A recent top ten list: anthrax, Halloween, the cartoon Dragon Ball Z, Osama bin Laden, Nascar, Britney Spears, American flag, mortgage rates, and PlayStation2.) A proprietary research product called Brand Buzz is sold to clients who want to know, for example, whether an upcoming movie has reached top-of-mind awareness with young consumers.

Yahoo will also help advertisers like Pepsi connect with its customers by building promotions like PepsiStuff.com, which invites consumers to collect points from under the caps of 20-ounce and one-liter bottles of Pepsi and Mountain Dew and then redeem them for digital downloads of songs, screensavers, e-books, and discount coupons. When the promotion ran last year--it's being revived this fall--Pepsi collected the e-mail addresses of 3.4 million soda drinkers. They haven't quite figured out what to do with them yet, but Pepsi says the ability to communicate with its customer base should prove valuable.

All that wins praise from advertisers. John Keck, director of global interactive media for Foote Cone & Belding in San Francisco, says, "Their data tracking, their knowledge of online behavior, their willingness to target, their ability to help us on the creative side--these are great assets." But does it amount to a turnaround for Yahoo?

It's hard to make the numbers add up. Yahoo has set the bar low for the fourth quarter, forecasting little or no growth in revenues or earnings. It won't provide guidance of any kind for next year, but to reach $1 billion in revenues in 2002, the company's sales would have to grow by 42%. No one expects that. So it will take at least until 2003 for Yahoo to match or exceed 2000 revenues of $1.1 billion.

"Now is not the time to buy Yahoo," says CIBC's John Corcoran. "It is very early in the recovery process."

The trouble is, evolution takes time. While Semel has been in charge of Yahoo for only six months, there are already whispers from some quarters that he's moving too slowly. In the media world there are those who think he needs to do a big deal to compete with sellers of advertising like AOL Time Warner and Viacom, which can offer multiplatform deals combining TV, online, and print. Advertising guru and economist Jack Myers says, "It seems almost inevitable that Yahoo would have to ally itself with one of the media conglomerates." On Wall Street some wonder whether Semel should try to transform Yahoo into a subscription service in a bet-the-company test of customer loyalty. If 10% of Yahoo's 80 million registered users agreed to pay $10 a month for e-mail, a calendar, a home page, access to chat rooms, and the rest, the company would generate nearly $1 billion in annual revenues before it sold any ads. "They should literally flip the switch on services they have traditionally offered for free," says FBR's Rob Martin. Another possibility: Make a deal with big cable operators to provide the front end of broadband services. "Otherwise," Martin says, "they run the risk of floundering as a second-tier media property."

The gang at Yahoo shouldn't be offended by all the kibitzing from the sidelines. It's actually a reflection of one of the company's great strengths: People like Yahoo, and they want it to succeed. As Starcom's Tobaccowala puts it, "Yahoo doesn't have the content that AOL Time Warner has, and it doesn't have the technology of Microsoft. But it has one asset: It isn't AOL or Microsoft." So advertisers, investors, and Internet users alike are rooting for Yahoo. Too bad good will, like Internet traffic, isn't easily converted into cash.

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