- Yahoo could still be a strong turnaround story as it continues to focus on mobile.
- It still has 37 acquisitions that it has made over the last 20 months that it can monetize.
- The company has downside protection with assets in Asia that will prop it up while it turns around and gets a stronghold in video.
- Fair value is somewhere between $46 and $52, suggesting 15% to 30% upside.
Yahoo (YHOO) started out as one of the very first email and search services, yet it quickly fell from grace as Google (NASDAQ:GOOG) jumped into the scene. Since then, shares have been fledging. Marissa Mayer has been running point for two years and it remains questionable as to whether we're in turnaround mode or just a slow downward spiral.
I believe the turnaround is still possible, it's more a matter of when. I'd expect there to be a higher ramp in marketing and product development where the company continues to implement a roadmap for a more personalized and mobile-oriented Yahoo.
Mobile drives the future
The mobile segment continues to outpace the desktop, and this is where the growth prospects lie. CEO Marissa Mayer has made mobile a focus. The mobile segment is the fastest growing and highly profitable segment.
Over the last two years, Mayer has concentrated on strategically acquiring companies that do well in bringing in mobile users and increasing engagement. Over the last twenty months, the company has made 37 acquisitions, with Tumblr being the most well-known and Vizify being the latest one. Even though it might take some time to figure out monetization strategies for these apps, it will definitely bring Yahoo more of the growing mobile segment.
The focus on monetization strategy
Increasing the share of display ads has become Marissa Mayer's personal mission. She fired the COO, Henrique de Castro, in hopes of re-energizing the company. Mayer is looking to improve the company's sales over the year with the new and improved product.
She's been working on Yahoo Mail and Flickr. She's doing a decent job of revamping the company's image and brand, but there is still much work to be done. As mentioned, the company has now shifted strategic focus toward investing in its product offerings - reflected by a 13% year-over-year increase in product development costs.
Some headwinds involve continued revenue decline and margin compression
Not only is Yahoo fighting with Google and Microsoft in the video and search space, but it's also fighting itself. In an effort to monetize its assets and grow, it's squeezing margins. And on the other hand, revenues continue to fall.
During 4Q, display and search revenues were both slightly higher than expected, but they declined year-over-year. Net revenue was down 1.7% Y/Y and display revenue was down 6% Y/Y, led by a 10% decline in APAC.
One bright spot was that search revenue grew 8% Y/Y. However, global query volume growth decelerated to 17% Y/Y. Declines in price-per-click on search traffic continues to mute revenue growth.
On the expense side, sales and marketing expenses were up 10% Y/Y, and product development costs were up 13%. Traffic started to grow again in the middle of last year, but that hasn't necessarily resulted in revenue growth.
One sour spot is that Yahoo still wants to re-architect its search business. I think Yahoo will only maintain its position in search relative to Google and Microsoft and will be more confident in the turnaround as we hear Mayer continue to preach the real growth story.
Which includes bringing more marketers to the new and acquired platforms to run display, mobile, video and native advertising formats. Now that traffic is beginning to stabilize, I'd look for that to be the incremental investments out of the C-suite.
There's money to be made in the confusion
Alibaba is still anyone's guess, but that's where the investment opportunity lies. The valuation for Alibaba ranges from $120 billion to as high as $200 billion. The consensus is $150 billion.
Its core business is still fairly strong and deserves to be trading higher than the roughly 6.5x earnings it's currently trading at. I feel comfortable paying around 10x its core business. At 10x, that's a more than 75% discount to Yahoo's pre-financial crisis historical average. It's also a 25% discount to Microsoft's average multiple during the five-year lull that it has traded in over the last half decade. Meanwhile, Yahoo still generates nearly 10% returns on investment and a 7% free cash flow yield with its core business.
Assuming the core business is worth around $17.5 billion, we can then better analyze Alibaba. Yahoo plans to sell 10% of its 24% stake to raise cash for "strategic investments." Thus, for fair value today, I'd assume a $150 billion value for Alibaba, which adds around $28.50 a share in value to Yahoo's stock, putting fair value around $46.
Another way to look at it is that Yahoo may well look to sell its stake in two tranches. I'm also assuming that Yahoo can manage to keep/distribute its 14% tax efficiently (i.e. using a tax-free split-and-spin approach). In any case, if it disposes of its 10% at a $120 billion valuation and holds it 14% until the IPO, where the valuation could be $200 billion, fair value is $52.
Thus, fair value is somewhere between $46 and $52, or 15% to 30% higher than the current price.
On the flip side, assuming a $120 billion Alibaba valuation for both of Yahoo's disposals and fair value is $40 - that' my worst case. Under the best case, Yahoo holds out to the $200 billion Abiliba valuation mark, which puts upside to $56
Yahoo's valuation does have some downside protection thanks to Alibaba. Yahoo's remaining stake in Alibaba still accounts for most of its value and visibility of the core business remains poor. That's where the opportunity lies.
Ultimately, a right sizing of the Yahoo ship will lead to stronger traffic and thereby revenue. One way to get this done is with acquisitions. I'd also look for the focus to be on shifting to new ad products and the shoring up of its video capabilities, which is where the Alibaba cash will come in handy. For video, the potential addressable market is large and growing. Yahoo is already making the move to grow its streaming video inventory with differentiated content to offer its existing brand advertising clients a natural outlet for their TV campaigns. All in all, the ultimate upside could be to $56, but in the least, I think fair value is somewhere between $46 and $52.