How Should Yahoo Spend The Alibaba Money?

May. 9.13 | About: Yahoo! Inc. (YHOO)

It looks like Yahoo (NASDAQ:YHOO) will get its hands on loads of money when Alibaba has an IPO in the near future. Alibaba's current value will not be known until the IPO happens; however, there are a lot of "guesstimates" by analysts that make it seem like Yahoo will be very happy soon. Keep in mind that Yahoo owns only 23% of Alibaba, but this is a large enough stake to bring Yahoo billions of dollars. Once Yahoo gets its billions from Alibaba, there are a number of things it can do with the money.

Alibaba reported a profit of $642 million in the last quarter, which compares very nicely with $237 million reported last year in the same quarter. Obviously, when a company is in a double-digit growth mode, its valuation will be set higher because of future profit expectations. Alibaba was also able to post a revenue growth of 80% as its quarterly revenue totaled $1.8 billion.

Alibaba's business model is highly profitable with healthy and sustainable margins. Instead of directly selling merchandise, the company offers a platform for sellers and collects commissions. This is very similar to what eBay (NASDAQ:EBAY) does. In addition, the company also invests in social media and other Internet-based ventures for growth. Morgan Stanley expects Alibaba to report a profit of $2.18 billion for the full year, which represents a 192% growth rate over last year's profit of $746 million. Recently, Alibaba purchased an 18% stake in Weibo, which is basically China's Twitter. The website has 50 million daily active users, which should help Alibaba's growth further.

Some analysts speculate that Alibaba might be worth as much as $100 billion, which would make Yahoo's stake in the company worth around $23 billion. Given Yahoo's current market value of $29 billion, Yahoo's stake in Alibaba is huge. Currently Amazon trades for $118 billion as the company reported a loss of $39 million in 2012, and a profit of $631 in 2011. Amazon's best year was 2010, when it reported $1.15 billion in profits and Alibaba is expected to earn double the amount this year. On the other hand, Baidu (NASDAQ:BIDU) reported a profit of $1.66 billion in 2012 and the company trades for as low as $32 billion. Yahoo could get anywhere between $6-7 billion to $25+ billion from its stake in Alibaba depending on whether the investors trade the company similar to Baidu or Amazon.

I definitely expect investors to put a higher valuation on Alibaba than Baidu because Alibaba has many advantages that Baidu doesn't, such as being active in the mobile space, more user engagement, faster growth, a larger variety of services and products being offered. Alibaba's value at the IPO could be anywhere between $60 billion and $100 billion depending on the state of the stock market at the time of the IPO.

Now here is the real discussion: how should Yahoo spend the money it will get from Alibaba's IPO? For a while, Yahoo's share price has been depending mostly on Alibaba rather than Yahoo. Whenever we hear something positive about Alibaba, Yahoo's stock price goes up, and whenever we hear something negative about Alibaba, Yahoo's stock price goes down. Yahoo's investors expect the company to get a large amount of money from Alibaba's IPO, and I am sure that they also expect the company to put this money to a good use.

The company could use the money to buy back shares, which could effectively buy the majority of Yahoo shares in the market, making the company almost private. Alternatively, the company could implement a one-time dividend payment to reward its loyal investors. The company could also acquire another private company and let it grow for its own IPO. Of course, Yahoo could also invest in new projects that will bring growth to the company.

Yahoo's revenues have been on a decline for the last five years or so. In 2008, the company generated about $7 billion in revenues, which fell to $6.4 billion in 2009. In 2012, Yahoo generated $4.98 billion in revenues, which may or may not signify a bottom. The analysts expect Yahoo to stay flat in the short and medium term. The analysts expect Yahoo to earn $1.24 per share in 2013, $1.35 in 2014, $1.27 in 2015, and $1.18 in 2016. Keep in mind that these estimates would exclude one-time costs or gains, such as the money Yahoo will receive from a future IPO of Alibaba.

In order to make investors happy, Yahoo needs to grow. Paying a one-time dividend will not help the company's valuation in the long term as it will attract dividend hunters for a short term just so that they can collect that one-time payment. Buying back shares of Yahoo could work if it's done over time. That way, the company could show EPS growth even when actual earnings remain flat year to year. On the other hand, investing in projects that will result in growth would provide the most value for the current shareholders. If I were an investor of Yahoo, I would want a mix of share buybacks and growth-generating investments.

Normally, Yahoo is not very cheap but it becomes very cheap when we factor Alibaba in. After all, Yahoo seems to have hit a gold mine with this company. Let's hope that the company puts the money it will get from the IPO to good use.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.