Although Yahoo's(YHOO) stock price has grown rapidly in recent quarters, Yahoo still appears cheap. The market is undervaluing the company's investment in Alibaba and under-rating the significant potential for Yahoo's investment in Alibaba to deliver value even after the Alibaba IPO. In addition the market is not giving sufficient credit for the significant recent improvements in the Yahoo's core business prospects.
The following analysis involves many assumptions which are subject to user interpretation. If you would like to experiment with changing some of these, please see the full interactive model.
According to recent figures released by Yahoo, Alibaba is growing its Revenue very nicely indeed and its Net Profit is also showing strong growth:
To provide a rough valuation for Alibaba we could use Facebook(FB) as a comparative stock. Using a stock price of $52.1, this implies a Market Capitalization of $123.6B. Currently Facebook has Net Profit After Tax of $422M, then adding back Stock Based Compensation we get an approximation of total cash-flow from operations of around $672M. Therefore Facebook is trading on a multiple of around 45.99 times its cash-flow from operations.
Facebook Equivalent Multiple (Based on Free Cash-flow)
Stock Based Compensation
Using this as a comparative multiple would indicate that Alibaba will be worth around USD130B (45.99 times 707,000,000 times 4). Considering that Alibaba is still growing both its top line and bottom line, by the time the IPO occurs, which is possibly up to a year away, we could easily add 20% to the Net Profit figure and therefore 20% to the valuation. This would value Alibaba at $156Billion.
Yahoo will be selling 9.54% of Alibaba which using the above valuation of Alibaba will generate $14.89B before tax. The company is obviously going to make this transaction as tax efficient as possible but is likely to have to pay close to the US Corporate Tax rate. Therefore using a Tax Rate of 35%, the share sale will generate $9.682B after tax. The value of its remaining holding in Alibaba will be $22.5B.
The company has recently valued its stake in Yahoo Japan at $11.406B and has Net Assets of around $4.4B. The underlying business generates $180M in free cash flow (Net Profit After Tax of 99M plus Stock Based Compensation $81M). Even using a very conservative multiple of 8 which would be applicable to a mature low growth stock, this yields a valuation of $1.437B. In total the company post IPO will be worth around $48B which implies a stock price of $47.47.
Valuation of Yahoo Japan
Stake in Alibaba
Value of Underlying Business
Improved Relationships Between The Two Companies
Yahoo does not need cash and in fact has been deploying significant amounts of cash in buying back stock. Current management are in no doubt aware that the investment in Alibaba, being in high growth markets is delivering a better return on capital than the company would achieve if it repatriated the funds. That is, the longer the money stays with Alibaba, the better. Since the Alibaba float still does not have a firm date this is excellent news for Yahoo.
Given Yahoo are happy with the money being invested in Alibaba, the company were pleased to announce a reduction in the stake it is required to sell post Alibaba IPO. Yahoo was previously required to sell half of its 24% current stake but has recently re-negotiated the amount of shares it is required to sell down to 9.54%, meaning Yahoo will still own 14.46% of Alibaba post IPO.
Note that the amount of the shares to be sold is a maximum figure. It could be lower and may be dependent upon Alibaba's ability to provide the required amount of cash, a not insubstantial figure of between $USD10Billion and $USD16Billion (depending on the IPO price). Post Alibaba IPO, approximately 47% of Yahoo's valuation will still attributable to its investment in Alibaba.
Future Co-Operation - Even More Value
The fact that there is communication and co-operation between the two Managements seems a very positive sign and the related press release would imply that further co-operation between the companies is planned. The importance of the improvement in relationships between the two companies' managements cannot be understated.
Originally Yahoo was an investor and mentor to Alibaba. Since that date, Alibaba has of course grown out of all expectations and is an important player in markets (China, Hong Kong, South East Asia etc.) whose potential dwarfs that of even the US market. However Alibaba has far more limited presence in markets where Yahoo is big, notably the US and to a lesser extent Europe. If ever there was potential for very effective co-operation between two co-owned companies Yahoo and Alibaba represent a textbook case.
The products that the companies distribute have limited overlap. Therefore if Yahoo was to provide assistance in the form of distribution and marketing for Alibaba products and vice versa for Yahoo in Alibaba's home territories this could add huge value to both companies. Yahoo is a trusted brand in the US and therefore its assistance in distribution would greatly reduce marketing costs for Alibaba. Alibaba needs to establish a presence in the US will have to compete against established players such as Ebay and Amazon in some spaces.
In China, Indonesia, Vietnam and other growth markets Yahoo is probably seen as a bit of a tired old world brand but it does have demonstrable expertise in markets where Alibaba would probably quite like to have a presence such as distribution of US film and sports content, and Internet Search. There seems great possibilities for co-operation between the two companies.
Yahoo's Core Business
After several years of decline Yahoo appears to be turning the corner in page views where it is growing again and has overtaken its 2011 level. The growth is even stronger in the US which is important as the US is its biggest market in terms of revenue. There are also signs that its new forms of advertising are gaining traction, particularly for mobile devices. Greater user numbers will mean that advertisers will be willing to pay more, therefore potentially stopping the reduction in payments per click that the company has experienced over the past few years.
From 2014 onwards the company expects to see some increased revenue from its recent acquisition frenzy as it quietly embeds its advertising model in the acquired product range.
The company is now showing dynamism, positive trends in some important metrics and is getting well positioned in all the high growth areas of the internet and social media.
What To Do With All That Cash
Post IPO, Yahoo will need to effectively utilize the money it receives from the IPO in addition to its existing cash balance of around $3B. The company is likely to continue with its current program of acquiring some smaller niche players, concentrating particularly on Mobile where it sees the biggest growth potential, but it could do this using cash-flow from operations.
The question remains what Yahoo will do with its future cash pile which could be around $12B. Assuming by then that the company can demonstrate that its new acquisitions are starting to be accretive and that the work done on its core business is starting to bear fruit, Yahoo should feel confident enough to acquire some larger targets and/or perhaps make some more radical improvements and additions to its product range internally in order to start growing its scale again.
Yahoo is on a very stable financial footing with a well managed core business that is starting to capture the imagination of users across the internet. The company will have a large amount of capital invested in high growth markets via its continuing investment in Alibaba and a sizeable and profitable investment in Yahoo Japan. In addition should the turnaround story continue, Yahoo should have the confidence to utilize its large cash pile to start expanding again in its core markets and new markets.