Seeking Alpha
Long only, deep value, special situations
Profile| Send Message|
( followers)  

Yahoo's (NASDAQ:YHOO) core business is still in trouble, and its financials and fortunes still rely heavily on Yahoo Japan and its stake in Alibaba. The rising stock price has benefited the company's stockholders, even though this is largely due to the growing value of Chinese e-commerce giant Alibaba. In the second quarter of 2013, revenues at $1.14 billion were a 7% decline over the previous year and operating income at $137 million was approximately 12% of revenues. However, net income surged to $331 million for an operating margin of 29%, and diluted EPS was $0.30. The bottom line was largely made up of combined earnings from Yahoo Japan and Alibaba, totaling $225 million, or 67% of Yahoo's total net income.

In its core businesses, display revenues of $472 million show a 12% decline from the previous year. The real disappointment was the 2% year-over-year decline in the number of ads and the substantial decline of 12% in the price per ad. Search revenues at $418 million for the quarter represented a 9% decline year over year, and although the number of paid clicks increased by 21%, the price per click declined by 8%. To be fair, even Google (NASDAQ:GOOG) -- the heavyweight in the search business -- reported the same trend.

The revenue per search (RPS) guarantee with Microsoft (NASDAQ:MSFT) has been extended for another year, and Yahoo will receive fixed quarterly payments. It will be investing in search to propel its growth in search, and is working actively with Microsoft's Bing to increase search usage. However, the company does not expect this arrangement to have a substantial impact on revenue growth. In the search market in the United States, Bing has increased its market share to almost 18% at the expense of Yahoo, whose share had fallen to 11.4% in June.

The Importance of Alibaba

Many experts believe that the value of Alibaba could be more than $120 billion because of its dominant position in the e-commerce market in China. This value is comparable to the current valuations for Amazon (NASDAQ:AMZN) and eBay (NASDAQ:EBAY). The business model that it follows is much the same as eBay in that it brings together buyers and sellers. However, its transaction volume (including Taobao and Tmall.com) of $180 billion was much higher than Amazon or eBay, and is growing at more than 70%. Additionally, its astounding net income margin is 48%. Alibaba's top-line revenues were $1.38 billion, and net income grew by an eye-popping 203% over the previous year to $669 million.

Alibaba is easily Yahoo's best investment, but it also presents a problem. Yahoo's 24% stake is probably worth more than the entire $16 billion worth of assets on its balance sheet. The stake was acquired as part of a $1 billion investment in 2005 and, in September 2012, half the investment was sold for $7.1 billion (before taking taxes into account). Half the remaining stake will be sold if there is an Alibaba IPO before the end of calendar year 2015. If an IPO does happen, Alibaba is less likely to be interested in the highest possible price because it has plenty of cash and would likely prefer to focus on strong performance thereafter.

The Tumblr Acquisition

New CEO Marissa Mayer has spent about $1.15 billion on acquiring 10 companies, but the lion's share of the spend (just under $1 billion) was for Tumblr. Investors wondered why Yahoo was spending this kind of money on what they regarded as just a blogging website. A recent filing shows that the company acquired $1.1 billion in assets and $113.8 million in liabilities, and that goodwill was an enormous $750.9 million. The goodwill was explained in the company's statement: "The acquisition of Tumblr is expected to bring a significant community of users to the Yahoo network." It must be pointed out that this kind of goodwill valuation is not unusual for a promising Internet startup. Clearly, Mayer is focused on the long term.

These acquisitions have a certain logic to them if you look at the underlying strategy. They are all focused on mobile users in addition to occupying niche markets. In some cases, the companies were acquired for talent that can be used to develop its own product pipeline. It can then focus on leveraging its own user base as well as that of Tumblr to sell its own products and ultimately attract advertising.

The Bottom Line

Mayer has been a breath of fresh air after the sorry procession of earlier CEOs, and the effect is already being felt in the rise in Yahoo's stock price. She is aggressive and proactive and willing to provide the long-term vision and planning that has been so sadly lacking the past few years. The company's current market capitalization is around $28 billion and if the valuation of Alibaba at $120 billion is taken into account, this investment alone is worth around $29 billion. This means that you are getting the best of the company for free, including the valuable stake in Yahoo Japan. If you believe that Mayer can make a difference in the long run, you should buy this stock because of the significant potential for upside.

Source: With The Value Of Alibaba, The Rest Of Yahoo Is Free