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Introduction

Yahoo (YHOO) has been the perennial under performer in the Internet segment despite having a head start in the 1990s. The company has one of the most popular web portals and gets a huge amount of traffic at its properties like Yahoo Finance, Yahoo Sports etc. The company has also got the 3rd most popular search engine after Google (GOOG) and Microsoft (MSFT) Bing. Despite having such valuable assets, Yahoo has never really managed to realize its potential with the stock price essentially going nowhere in the last 10 years. Yahoo missed a huge opportunity when it declined to accept Microsoft's offer of a buyout at a huge premium at $31/share. Jerry Yang who was the CEO at that point of time let his pride come in the way of money by refusing to sell the company. The company's top management in the past has been one of the worst amongst large cap Internet companies.

However, the most recent CEO Mayer is showing promise. The company is in the early stages of a turnaround and we think it is a good buy at this point. We see little in the way of risk, as the company has great assets which provide a solid floor price for the stock. We think as the technology industry consolidation accelerates, the company will become an attractive acquisition target for one of the technology heavyweights.

Yahoo Positives

  1. Management Change - Yahoo appointed Marissa Mayer from Google to lead the company in July, 2012 and the change in the top echelons of the company is already showing promise. Yahoo always had great assets but the top management was quite bad. The new CEO has placed emphasis on retaining and attracting employees. This is essential since Yahoo has been perceived as a bureaucratic labyrinth, where things did not really get done. With the stock price rising, employees with stock options will have an additional incentive to contribute towards Yahoo's turnaround. Mayer has taken a number of initiatives like overhauling its online services and signing a pact in display ads with Google. The company no longer is the main threat to its earlier rivals like Google and Microsoft. It is using this to its advantage by partnering with both strategically. We have found that the new changes to Yahoo Mail and the Yahoo home page has been received quite well by users.
  2. Tremendous Internet Assets - Yahoo's biggest strengths are its highly popular Internet websites like Yahoo finance, Yahoo mail, Yahoo news, search etc. The company gets a stunning ~700 million users a month, which makes it the 3rd most popular network. Though the company has faced problems in monetizing its traffic (similar to Facebook), the company is trying to increase profits by partnering with other companies and reducing internal costs.
  3. Mobile Focus - It is essential for all Internet companies to focus on the mobile phones, as more and more traffic is shifting from the desktop towards smartphones. Yahoo is not getting left behind with 50% of its engineering talent now focused on mobile technology. Yahoo has great properties that could really benefit from the secular shift to mobile phones like weather, financial quotes, home page etc. The company announced that it had got 200 million monthly users of its properties through mobile phones.
  4. Alibaba Holdings - This is one of the best investments that Yahoo made buying a 40% stake in Alibaba for $1 billion in 2005. That $1 billion is almost equal to $15 billion now, as Alibaba is being valued at $38 billion. While Yahoo has sold a 20% stake in the company already, the 20% stake that is left is equal to $7.6 billion, which is almost 30% of Yahoo's current market capitalization of $25 billion.
  5. Decent 4Q12 Results - The company delivered decent 4Q12 results in which revenue grew by 4% y/y and operating earnings grew by 28% y/y. Free cash flow generation of $221 million was also pretty good showing that the company despite its numerous stumbles is still managing to generate a large amount of cash.
  6. Solid Balance Sheet - Yahoo has got a solid balance sheet with net cash of ~$4 billion which accounts for almost ~16% of its market capitalization of $25 billion. The company generates $1 billion dollars in free cash flow from its business.

Yahoo Risks

  1. Yahoo Board and previous management - Yahoo's board and previous series of CEOs have been a total disaster for the company. First Jerry Yang was replaced for botching up the MSFT offer. Then Carol Bartz was fired for incompetence in 2011 after replacing Jerry Yang. The last CEO Scott Thompson was let go for fudging his resume, which came to light after investor Dan Loeb found holes in his past experience. The earlier CEOs had to be fired because of plain incompetence and non-performance. Yahoo's current stock price surge is mainly due to the fact that it seems that Yahoo has finally found a decent CEO after going through 5 CEOs in the last 5 years.
  2. Revenues and Margins all over the place - Yahoo's revenues and margins have fluctuated quite wildly in the past years. Revenues in the past 5 years have declined from ~$7 billion in 2008 to ~$5 billion in 2011. Operating margins have also fluctuated between 6-20% in the last 10 years, which has also made the EPS figures go up and down. The company is projecting revenue growth at only 0.7-3% in 2013.
  3. Lost out on most Internet trends like social networking, online games etc - Yahoo has ranked very low on innovation compared both to older companies like Google and newer ones like Facebook (FB). The company never had a presence in social networking and has failed to innovate. Google in comparison has done a stellar job in innovation bringing out/buying new products like Android, Youtube, and Orkut etc. Yahoo has acted more like Microsoft in this respect.

Valuation is Cheap on a P/B basis

Yahoo's valuation is not expensive at ~15.6x forward P/E, with its P/S and P/B at 5x and 1.6x. The company seems a bit undervalued given that it has highly valued assets. However the lack of growth has kept this ratio low. The company has not grown much in the last 3 years, even as its competitors like Google, Facebook have increasingly captured a larger share of the advertising pie.

Stock Price Performance

Yahoo stock has declined by ~28% over the past 5 years significantly underperforming most of the other large cap Internet stocks. The stock has traded in a range of ~$10 to $30 in the past 5 years and is currently trading in the middle of that range currently. Yahoo has seen its all time high of $48.5 during the 2000 Internet boom and has not touched that figure ever since. However, over the past year the stock has given a nice return of ~29%. The stock has gone up by almost 38% in the last 6 months, as the general market has gone up and also due to better performance under the new CEO.

Summary

Yahoo remains a formidable force in the global Internet industry despite the abysmal performance by its top management. Despite numerous mistakes, Yahoo still manages to generate more than a billion dollars in free cash flow every year and gets over 700 million visitors to its web properties every year. The change in the top management is a big positive for the company. We think that the newer management can grow the company at decent rates. As technology wars heat up between the global heavyweights, Yahoo will increasingly come into play for its valuable content assets. Microsoft had valued the company at $31/share, 5 years ago which is a premium of almost ~55% to its current stock price. We think that Yahoo remains a buy due to its valuable assets base and may offer additional upside if the new CEO can generate faster growth.

Source: Yahoo - Management Finally Unlocking Asset Value