The share price of Yahoo! (NASDAQ:YHOO) has increased substantially in 2013. With that in mind, should investors continue to be bullish on Yahoo? To answer that question, I'll do strategic analysis, analyze the Alibaba stake, and apply a few valuation models.
The answer to the question is "yes." Although Yahoo! faces increasing competition in its core business of selling Internet traffic, successful investments in Alibaba and Yahoo! Japan are boosting the value of Yahoo!'s common equity shares. If Alibaba is priced at the high end of the rumored valuation range, core Yahoo! would be selling for about $1 billion based on the market capitalization of the firm.
With that and more -- which follows later in the report -- in mind, I'm looking to get long shares of Yahoo! during a decline in the share price. In other words, based on the valuations, I don't think the rally in the share price and valuations of Yahoo! are overdone.
Strategic analysis is a key component of evaluating the future growth prospects of Yahoo! The company faced competition from Google (NASDAQ:GOOG) during the past decade and now faces competition from Facebook (NASDAQ:FB) and Twitter. Thus, it is important to assess the industry dynamics impacting Yahoo! I'll examine the bargaining power of customers and suppliers. That is in addition to covering substitute offerings and new entrants.
Yahoo! sells internet traffic to advertisers; its customers are businesses and its suppliers are people. Since the late 1990s, the Internet has become increasingly competitive. Google took market share from Yahoo! in search, and Facebook and Twitter now have a substantial share of Internet traffic. Yahoo! also aggregates news and videos from around the Web; those features could retain or increase suppliers. But, suppliers and customers have bargaining power, which should adversely impact profitability.
While Yahoo! is attempting to expand its services to increase the switching costs of suppliers, I doubt the investments in mobile and video will be highly successful over the medium term. When I look at the competitive landscape, in terms of substitute offerings and new entrants, I think Yahoo!'s profitability will be adversely impacted over the medium to long term.
Overall, the strategic analysis of core Yahoo! is bearish for the valuations of the firm because of limited growth opportunities. That said, Yahoo! could be a great investment near term. Part of that belief stems from the upcoming Alibaba IPO.
The Alibaba IPO that is coming in the next few quarters is an important part of Yahoo! analysis. The IPO is important to the Yahoo! valuation and potential returns of capital to investors. Alibaba seems likely to list its shares in New York.
The China-based Alibaba is seeking an equity structure that will allow its founder to maintain control of the company. Hong Kong officials are saying they won't allow the proposed structure. Consequently, Alibaba could offer its shares in New York. There are rumors that Alibaba could be valued in the $70 billion to $100 billion range.
Alibaba could post revenue of close to $10 billion in 2014. The 2013 revenue growth rate could be in the high double digits. With Yahoo! owning about 24% of Alibaba, Yahoo!'s stake could be worth up to $24 billion.
Yahoo! could sell a portion of its Alibaba stake during or following the IPO process, which would leave Yahoo! with a significant cash balance. According to Yahoo!'s management, investors should model a minimum cash balance of roughly $3 billion. So, Yahoo! could return cash to investors following the Alibaba IPO process.
Alibaba may not go public until the first half of 2014. Also, there are a lot of other factors to consider when deciding to invest in Yahoo! In other words, financing outflows don't guarantee the success of an investment.
Taken by itself, the Alibaba IPO is bullish for the valuations of Yahoo! -- in my opinion. Next, I'll use valuation models to estimate the intrinsic value of the common shares of Yahoo!
I will use a few models to value the common equity shares of Yahoo! I'll use a simplified asset-based valuation. I will also use an estimate of investors growth expectations and the multiplier models. Yahoo! is less undervalued than it was 6 months ago.
Yahoo! is a good company to use in conducting a simplified asset-based valuation. According to the company's management, the Yahoo! Japan stake is worth $10 billion. The low end of the Alibaba valuation means Yahoo!'s stake is worth $16.8 billion. Combining those two businesses, Yahoo! would have a minimum valuation of $26.8 billion. The current market capitalization is $34.8 billion. Thus, core Yahoo! is valued at $8 billion by the market, which is 1.66 times twelve trailing months revenue and 12 times twelve trailing months operating income. If Alibaba is valued at $100 billion, core Yahoo! would be selling in the market for less than $1 billion.
What do investors think about the growth prospects of Yahoo!? Growth expectations are 53.5% of the current share price using twelve trailing months earnings. Using the median analyst forecast of 2013 earnings, just under 50% of the share price is attributable to investor's growth expectations. Growth is 38.5% of current share price using the median forecast for 2014 earnings. Overall, I think that is a pretty fair assessment of the company's growth opportunities; I think there could be room for upside considering the growth rates of non-core Yahoo! assets.
The multiplier models are appropriate for valuing the common equity shares of Yahoo! Compared to the historic valuations, Yahoo! is overvalued, but the historic valuations are low because the share price didn't increase much following the 2009 stock market low. The company is trading in line with the industry valuations. I think sales, earnings and book value should increase in fiscal 2014 and/or 2015. Based on this model, I would get long on a pull back.
Combining the output from all of the models, I would say that Yahoo! is fairly valued to moderately undervalued. The asset-based valuation provides a pretty high base value and suggests shares of Yahoo! are undervalued. Investors have built in a decent amount of growth into the share price, but there is room for upside. Given the growth rates of non-core Yahoo! assets, the multiplier model may be underpricing shares of Yahoo! The valuations support being bullish on shares of Yahoo!
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.