Struggling Core Business
Yahoo (NASDAQ:YHOO) is one of the businesses that survived the dotcom bubble, and it still exists today, although it has lost its early shine. The company could not keep its growth pace while Google (NASDAQ:GOOG) grew into a giant monster and dominated the search engine and internet advertising business. The data in the following table shows how big GOOG became and how it dominated the internet advertising business. GOOG held a little less than one third of the worldwide net digital ad revenue in 2012 and 2013, while YHOO had a 3.37% share in the net digital ad space that it lost in 2013. YHOO's market share decreased to 2.87% in 2013.
This performance is especially discouraging, considering the fact that there was an increase of around 14% in the total worldwide digital ad revenue that grew from $104.22 billion in 2012 to $119.52 billion in 2013. With the drowning core business (that makes up around one third of YHOO's value) YHOO needs an innovative product or service that really appeals to internet users to grow its core business in the future and justify its status as a growth tech stock.
Investment in Alibaba
A little more than one third of YHOO's value is attributed to its 24% stake in Alibaba. This part of YHOO has some glamour in it, and investors are very interested in seeing how this investment pays off, since Alibaba is up for an IPO in the US. It is not clear how much of YHOO's stake in Alibaba will be sold in the IPO, but the dominant belief is that YHOO will sell 14% of its 24% stake in the IPO.
Alibaba's IPO is surrounded by a lot of buzz, and investors are really looking forward to a company whose top line growth looks similar to Amazon's (NASDAQ:AMZN) but is still profitable. AMZN only focuses on its top line, and its "hoped for" profit prospects are quite uncertain. Alibaba's operating margin is around 44.6%, making it a company with a profitable business model.
China is the focus of businesses and investors in the US, since they expect a good growth and return from this rapidly growing emerging market with nearly 1 billion customers. Apart from the fact that it originated in China, Alibaba's business has some really interesting features.
Alibaba is a gigantic company that caters to around 80% of the Chinese e-commerce market. A big part of its business is somewhat similar to that of the eBay (NASDAQ:EBAY) marketplace in which it provides a platform where buyers and sellers meet. It also has many other growth business segments that include e-currency Alipay, social media services, an email service, and messaging apps like Tango.
Alibaba's two shopping websites, Taobao and Tmall, delivered around half of all parcels delivered in China, and they are handling volumes that are much higher than AMZN and EBAY. Last year, there was around $160 billion worth of volume handled by Alibaba's shopping websites. In the previous quarter, Alibaba's revenue grew from $792 million to $1.78 billion at a growth rate of 51%.
YHOO is very excited for the Alibaba IPO, since YHOO is expected to make a good return by selling its stake in Alibaba. A good return is expected especially due to the ongoing hype regarding the value of Alibaba that may lead to an IPO price with an unreasonably large premium built in it. This point was made by valuation guru Aswath Damodaran. He argues that Alibaba, with $8-$9 billion worth of revenue, should not be valued at $150 billion; this is the value that a good part of the market is expecting Alibaba to have. In his view, this value is way too high, and it's like building premiums on top of premiums, since there is not much data to support such high valuations.
What I have gathered from his argument is that the current buzz around the valuation in the market is not based on the numbers, but is instead based on the facts that cannot be translated clearly into a valuation. Currently the valuation made by many analysts is based on the interesting stories about Alibaba that are out in the market, and these stories are selling well. Stories are selling well because that is what the market wants to hear at the moment. Alibaba is a Chinese company, and this draws attention to the fact that companies in China not only do well because they are great companies, but also because of the fact that they are supported by the government. Their performance is likely to be adversely affected if there is free competition. There is a concern that such speculation without enough data to back it up would cause the price of Alibaba to go well above the true value of the company.
This is exactly what YHOO would want. Speculation about Alibaba's IPO is expected to give YHOO a good gain in its stock price. YHOO will perhaps yield good returns from selling a portion of its stake in the IPO, but what next? What other growth areas does YHOO have for the future? If YHOO does not have opportunities good enough to allow a turnaround, then the company should seriously think of returning a good portion of IPO proceeds to shareholders.
YHOO has produced a great return of around 145% in the last two years, and that was due to the fact that the market wanted YHOO to turn around. But its financial performance has not improved, and there is no clear indication of a hoped-for turnaround. YHOO seems to be slowly spiraling out of control. The company is expected to make good return by selling its stake in Alibaba, but Yahoo's management has nothing exciting that can lead the company to growth in the future. Investors should stick with YHOO while the market is excited about Alibaba. Once the Alibaba's IPO is initiated, investors should then reassess YHOO's situation to determine whether to stay invested in the company or not.
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.