Yahoo: Short The Alibaba IPO Hype

Mar.17.14 | About: Yahoo! Inc. (YHOO)

Summary

A possible Yahoo rally on Alibaba IPO hype could provide a short opportunity.

Yahoo still has growth problems, cash doesn't always solve that.

An upcoming change could alienate users.

Valuation stretched already, could get even worse.

On Friday, we received news that Alibaba could be going public as soon as next month. This news sent shares of Yahoo (NASDAQ:YHOO) higher, as the US name looks to monetize its Alibaba stake. Investors have been patiently waiting for the Alibaba IPO, and it appears closer than ever. This IPO could be a large positive for Yahoo shares, and BofA/Merrill thinks shares could trade up to $45 in response. That's a strong rally from Friday's close of $37.60, and I think that an Alibaba-IPO rally for Yahoo would create the perfect short opportunity for investors. Today, I'll detail why.

A lack of growth is troubling:

Right now, Yahoo's growth is basically nonexistent. Investors love the stock for the Alibaba stake and the Yahoo Japan stake, but that's it. When compared to others in the space like Google (NASDAQ:GOOG) or even AOL (NYSE:AOL), Yahoo is left in the dust. In the following table, I've compared these three names in terms of expected revenue and earnings per share growth for this year and next. These are based on current analyst estimates. The estimates for Yahoo are non-GAAP for both revenues and earnings per share, and the Google and AOL earnings per share numbers are non-GAAP as well.

Yahoo trails by a mile in terms of expected revenue growth. Yahoo is well behind in EPS growth as well, and that includes the fact that the company is buying back a ton of stock right now. Imagine what the EPS numbers would look like if it wasn't for the buyback. In 2013, the company reported a decline in both GAAP and non-GAAP revenues. Non-GAAP EPS were up by 16% in the year, but the share count was also reduced by more than 10% thanks to the buyback. You can view all of Yahoo's recent results in the 10-K filing.

There was mixed reaction from analysts to Yahoo's Q4 report, which sent shares lower. Evercore was not happy about the slowdown in Alibaba's growth. With worries about growth in China, those fears could only increase. Yahoo has been an Alibaba derivative investment for a while, but what happens down the road? In this market, growth is favored, and Yahoo does not have it. While Cantor upped its price target, the firm noted Yahoo's continuing display and search ad losses. Cantor also said that CEO Marissa Mayer and her team are "on the clock" for delivering Yahoo's turnaround. Looking at the table above, Yahoo needs to get its growth going. Shares won't trade off Alibaba forever.

Cash seems good, but what's the use?

When Yahoo sells a piece in the Alibaba IPO, it will get a chunk of cash back. The phrase "cash is king" always seems important, but the use of that cash is important. In the 10-K linked above, Yahoo had a little more than $5 billion remaining on its current stock buyback program. It is likely that Yahoo will use a chunk of the Alibaba cash to continue to buy back shares.

Yes, the buyback will reduce the outstanding share count further and will boost EPS. But as you saw in the table above, EPS growth is below competitors already. Google's share count is rising and yet the company is still growing EPS strongly, thanks to a rise in net income. Will that be the case with Yahoo? Probably not, as net income growth will trail EPS growth thanks to the buyback.

Additionally, Yahoo could end up in Apple (NASDAQ:AAPL) territory. Apple has a ton of cash, and Apple is buying back plenty of stock. Apple's share count is coming down nicely, and that is really going to help Apple's EPS this fiscal year and going forward. However, Apple shares right now are not rising that much, because of growth concerns. Apple needs to deliver new products, something to get the growth story back on track. At the moment, Apple is actually projected for more revenue growth than Yahoo, which is pretty sad if you know where Apple's estimates stand.

Is Yahoo alienating users?

Recently, Yahoo made a decision to change access rules for its online services. Consumers will need a Yahoo ID to access services, instead of using Google or Facebook accounts. Yahoo believes its services have improved and that users will create a Yahoo ID. However, it probably will cost the company some users in the short term. This isn't the first time that a big name has changed access rules. Last year, Disney's (NYSE:DIS) ESPN changed its rules regarding comments. You now have to sign in via Facebook (NASDAQ:FB) to post a comment. This was aimed at cutting down on "trolls", or those who post unrelated and useless comments (garbage). As a result, I've seen a lot less comments on many pages, thanks to this change. Quality seems to be up, but traffic (regarding comments) seems to be down.

Will this change requiring users to have a Yahoo ID hurt the company? It certainly could, and it wouldn't be the first time that Yahoo has angered users. Yahoo has recently overhauled its Yahoo Finance page, and I for one think it was a giant step backwards. The new site seems to have more tech problems, and it now takes more clicks to get to certain pages (if I can even find them). Additionally, Yahoo made a huge change to its Fantasy Sports pages, which also was a terrible re-design. The initial outrage was enough that Yahoo had to come back with another new page, and still, the site is not as user friendly as it used to be. Yahoo changed the background so much that there were several complaints from color blind people who could not read the page. Yahoo needs to hope that this upcoming rule change doesn't alienate more users, because it would only stall growth even further.

Valuation already appears stretched:

When looking at Yahoo's valuation against the other names already discussed, Yahoo is the most expensive. In the following table, I've compared the four names discussed in terms of price to sales and price to earnings for 2014 and 2015. Remember, all of the P/E numbers below are non-GAAP except for Apple. Yahoo's P/S value is the only one that is non-GAAP.

*Apple numbers based off estimates for fiscal year, which ends in September 2014.

Yahoo is the most expensive on a P/E basis, and there is no arguing that fact. Even if you convert Yahoo's revenues to GAAP, the P/S premium still exists, although it is not as large. So my question here is what happens as Yahoo continues to reduce its Alibaba stake? Will Yahoo be able to grow revenues and earnings per share enough to get this premium down? With Yahoo becoming less dependent on Alibaba, I think the valuation could easily fall to an average of Google/Apple if the market doesn't like the growth picture.

Remember, all of the numbers in the table above are as of Friday's closing prices. If Yahoo shares rally to $45 like the one analyst suggested, these numbers will get even more bloated. That price is almost 20% above current levels, so add another 20% to the numbers above. That's where the argument for a short comes in.

Final thoughts:

Yahoo may soon rally as the Alibaba IPO approaches, and investors might want to be long through that process. However, Yahoo is becoming less dependent on Alibaba, and that means Yahoo will start to be judged on Yahoo, a business that's not doing much currently. Yahoo offers almost no revenue growth currently, trailing industry peers by a mile. Earnings per share growth also is lacking, and that's after the large boost from the buyback program. Yahoo trades at a rich valuation, even before an Alibaba-IPO rally. Should Yahoo get into the low to mid $40s thanks to the IPO hype, a short position in Yahoo may be worth a look.

Disclosure: I am long DIS. 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.

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.