- The Alibaba IPO is already priced into the stock and only a large run up post-IPO can result in profits for Yahoo shareholders.
- Summing core operations with Yahoo Japan and Alibaba at $150 billion results in today's market cap.
- Very little is known about what exact parts Alibaba will be listing and what those fundamentals are that will be supporting the valuation.
- Yahoo sales growth is barely positive (1.5% and 3% for next 2 years respectively) and thus does not justify a high multiple.
- Earnings in equity interests has played a major role in Yahoo's earnings. Once removed, focus will shift to operating profit that has dropped since 2010 and 2011.
With all the news on Alibaba's (ABABA) decision to list in the U.S. I decided to take a look at Yahoo (NASDAQ:YHOO) and see if there is an investment opportunity. Unfortunately, I found that the Alibaba IPO is priced in and a lot of hope has to become reality for current investors to outperform the market through a long in Yahoo. That being said, an Alibaba listing could result in a runaway price which would push Yahoo higher but as a value investor seeking a margin of safety it doesn't meet my standards.
To value Yahoo, I first took the naive approach of looking at earnings per share without looking at the content. But I think by taking this route, the conclusion becomes even more evident.
Let's start by looking at the average EPS over the last four years as stated by Value Line, 2013 earnings, and 2014 analysts' estimates. Then I assumed Yahoo should trade at multiples similar to old school tech - Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC), Apple (NASDAQ:AAPL), and Cisco (NASDAQ:CSCO). Based on Friday's close, these old school tech companies sold at a P/E of 11-14 times. See below:
As sales growth is expected to be 1.5% this year and 3% next year, I believe a high valuation is difficult to justify. Therefore, using a range of 10-15 and three scenarios for earnings, we have a projected market value. Yahoo conveniently has around one billion shares outstanding which makes our calculations simpler.
Using this market value and Yahoo's 24% stake in Alibaba we can project the potential upside. The table below shows the potential market cap of Alibaba ranging from $100-200 billion and the resulting upside in an investment in YHOO. Let's assume that Yahoo manages (one way or another) to sell its entire stake and pays a tax of 38%. Assuming a valuation of $150 billion, YHOO will receive $22.32 billion. Looking at Scenario 3 (analysts' estimates) and assuming the high P/E of 15 we calculated a market cap of $45.87 billion (22.32 from the sale + 23.55). If we take an average of the three scenarios together then we calculate a market cap of $39.87 billion which is only a 5% upside to the current market cap.
So the first conclusion is that not only does Alibaba have to complete its IPO and begin trading, it has to exceed current expectations of market cap ($150 billion) at some time in the near future when I do not know what the market sentiment will be. Not only do I currently not know the future market sentiment, I also do not know very much about what parts of Alibaba will be listed and what fundamentals those parts have that support the valuation. Therefore even by taking the naive approach I come to the conclusion there is little upside if any unless there is a super IPO...
Now if we look more closely at Yahoo's latest results we see that operating income was only $590 million and that the $1.4 billion in net income was a result of earnings in equity interests of $897 million. Now these equity interests are mainly Alibaba and Yahoo Japan. Yahoo Japan (OTCPK:YAHOY) has a market value of $32.82 billion. Yahoo owns 35% and so we can assume a value of $11.5 billion to Yahoo shareholders. Core operating profit is $590m or $383m after a 35% tax rate. Note that while operating profit increased from last year's $566m, it is quite lower than 2010 and 2011 ($773 and $800m respectively). Assigning a P/E of 10x to these core earnings gives us a value of $3.8 billion. Adding the core value ($3.8b) to Yahoo Japan gives us $15.32 billion. If we then deduct $37.95 billion of current market cap from $15.32 billion then we are left with $22.63 billion.
If we look at column 3 above, we see that if YHOO sells its stake in Alibaba at $150 billion valuation then it receives after tax $22.32 billion (or very close to the $22.63 calculated in the previous paragraph).
Therefore even if we take a slightly more detailed approach and value the three most important parts together, all we get to is today's market value. In order to justify a long position we would need: a) a super IPO (we can only guess currently), b) good market sentiment (another guess), and c) improving operating profit at Yahoo (a third guess)....