- Net of its stakes in Alibaba, Yahoo Japan, and its cash, Yahoo's core business is being valued at less than 2x operating cash flow.
- CEO Marissa Mayer and CFO Ken Goldman have made material investments to turn Yahoo around, and they are beginning to pay off.
- Once Alibaba becomes public, investor focus will likely shift to Yahoo's core business, which is set to improve further in 2014.
For most investors, the days when shares of Yahoo (NASDAQ:YHOO) (hereafter referred to as Yahoo for stylistic purposes) were valued on the basis of the company's underlying search and advertising business have long since passed. Many investors now see Yahoo exclusively as a trading vehicle through which to invest in Alibaba, China's largest e-commerce company, ahead of its IPO, which is set to occur this year. We have already discussed the appeal of Alibaba in a previous article of SoftBank (OTCPK:SFTBY), which owns almost 37% of the company, (versus Yahoo's 24% stake), arguing that when the true value of its equity stakes are added to its mobile operations, the company's intrinsic value per share is considerably higher than its current share price. Our analysis of SoftBank led us to begin considering the question of whether or not the same can be said of Yahoo. Is there value left in shares of Yahoo, given their more than 50% rally over the past 12 months, a rally that has outpaced the NASDAQ, Google (NASDAQ:GOOG), AOL (NYSE:AOL), and Microsoft (NASDAQ:MSFT), trailing only IAC/InterActiveCorp (NASDAQ:IACI)? On top of this rally, Yahoo, unlike SoftBank, has a core business that continued to stagnate in 2013.
We began examining the various pieces that comprise Yahoo's valuation, and what we found leads us to believe that at present levels, shares of Yahoo remain a compelling long-term investment, due not only to its stakes in Alibaba (as well as Yahoo Japan), but also its underlying search and advertising business. Most investors have written off Yahoo's underlying operations, and as we will show later in this article, these operations are being valued at less than $2 per share, versus Yahoo's March 28 closing price of $35.98. While it is true that Yahoo's underlying business has declined from historical levels, it is a business that continues to generate well over $1 billion in annual operating cash flow. And with Yahoo's revenues set to return to growth in 2015, we believe that now is the time to scale into a position in Yahoo, ahead of this turn in its operations. Taking into account the value of its stakes in Alibaba, Yahoo Japan, the billions in net cash sitting on Yahoo's balance sheet, and a fair, market-based value of the cash flow that Yahoo continues to generate, we see upside of over 32% for shares of Yahoo, and that is before taking into account any gains in the value of Alibaba once it completes its IPO. Unless otherwise noted, financial statistics and managerial commentary used in this article will be sourced from the following: Yahoo's 2013 10-K, its Q4 2013 earnings release, its Q4 2013 earnings presentation, or its Q4 2013 earnings call.
Yahoo's Equity Stakes & Cash: When Paper Assets Mask the Real Business
Most investors have largely written off Yahoo's underlying business, preferring instead to focus on the company's 24% stake in Alibaba. And why shouldn't they? Alibaba is China's largest e-commerce company, a company that is, as the Wall Street Journal says, "a mix of Amazon, eBay and PayPal, with a dash of Google thrown in." Given that Alibaba also owns 18% of Sina's Weibo unit (China's Twitter), the picture grows even more compelling. In the face of such a company, why would investors focus on a search business that has, at minimum, been mired in stagnation and a multi-year turnaround effort?
Yahoo's on-balance sheet financial assets consist of three entities: its net cash, a 24% stake in Alibaba, and a 35% stake in Yahoo Japan, which despite utilizing the Yahoo brand is a legally separate company (SoftBank owns 42.5% of the company, with the remainder floated on the Tokyo Stock Exchange). We break down the value of these three assets below (the valuation for Yahoo's stake in Yahoo Japan is based on the company's March 28 closing price of ¥514), utilizing Yahoo's current outstanding share count of 1,009,392,339 and a yen/dollar exchange rate of 102.964/1.
After Tax Value
Value per Share
Bloomberg Consensus Valuation
Value per Share
Together, Yahoo's stakes in Yahoo Japan and Alibaba are worth $30.13 per share on an after-tax basis, after applying the United States' full 35% statutory federal corporate tax rate. We note that if Yahoo is able find a more tax-efficient mechanism through which to monetize its holdings in Yahoo Japan and Alibaba, their value to the company would be even higher.
Before we continue to a discussion of Yahoo's cash & investments, we believe it is prudent to discuss our valuation estimate for Yahoo's stake in Alibaba. Our valuation of $23.65 per share for Yahoo's stake in the company is based on a Bloomberg consensus valuation of the company, based on the average valuation estimates of the analysts that cover the company. Valuing any company is more an art than a science, but this estimate of $153 billion is, in our view, the most precise estimate available for Alibaba before its public market debut. However, other estimates have ascribed valuations of as high as $250 billion for Alibaba, with Macquarie Group estimating Alibaba's value at up to $200 billion. Once Alibaba formally files its IPO paperwork with the Securities and Exchange Commission, thereby offering a detailed examination of its financials, Yahoo investors will have a far better understanding of Alibaba's potential value once it becomes publicly traded. Yahoo ended 2013 with $4.997394 billion in cash & investments (which does not include the book value of its equity investments in Alibaba and Yahoo Japan), and $1.110585 billion in debt. Based on Yahoo's current outstanding share count, Yahoo holds $3.85 per share in net cash.
Together, Yahoo's stakes in Alibaba, Yahoo Japan, and its net cash equal $33.97 per share. With Yahoo itself closing on March 28 at $35.90, this means that Yahoo's core search and advertising business is being valued at just $1.93 per share, far below what we believe to be fair value. We turn now to our analysis of Yahoo's underlying business.
Yahoo's Core Business: Finding the Embedded Value
While it is true that Yahoo's business is growing at a rate below that of Google, CEO Marissa Mayer has begun planting the seeds of a turnaround at the company, and although Yahoo's revenue has declined from its historical record levels, the company is in far less dire straits than its critics suggest.
Before we begin our analysis of Yahoo's business, we believe that it is important to place the company's decline over the past several years into a historical context, and in the table below, we detail Yahoo's historical revenue (on both a GAAP and ex-TAC basis) and operating cash flow in 2013, as well as the previous 15 years.
Yahoo Historical Performance, 1998-2013 (in Thousands of $)
Operating Cash Flow
Operating Cash Flow Margin
Operating Cash Flow Margin ex-TAC
Yahoo's revenues, on both a GAAP and ex-TAC basis peaked in 2008, and by the end of 2013, have declined by 35.07% on a GAAP basis, and 18.02% on an ex-TAC basis, which is the figure generally used by Yahoo investors to analyze underlying performance. We note that revenue figures after 2009 are affected by Yahoo's search deal with Microsoft, which significantly altered the economics of the company's search business, trading revenues for cash flow and profitability. While Yahoo's core business has certainly declined from historical levels, it remains fully profitable, with the company generating almost $1.2 billion in operating cash flow (cash flow figures for 2012 were significantly affected by cash tax payments on the sale of a portion of the company's holdings in Alibaba) in 2013, and nearly $800 million in free cash flow, which Yahoo has been using judiciously to repurchase shares and acquire select companies to bolster its talent base.
While Yahoo's headline revenue figures for 2013 tell the tale of a business that continues to gradually decline, a deeper analysis tells the tale of a company that is aggressively investing to turn its operations around, with early signs of success. We break down Yahoo's consolidated performance in Q4 2013 and the year as a whole in the table below.
Yahoo Q4 2013 & 2013 Results (in Thousands of $)
Display Revenue ex-TAC
Search Revenue ex-TAC
Other Revenue ex-TAC
Total Revenue ex-TAC
EBITDA Margin ex-TAC
Operating Margin ex-TAC
*Other revenue includes revenue that Yahoo generates from royalties from joint venture partners, listing-based services, and transaction revenue
As the table above shows, Yahoo's consolidated ex-TAC revenue fell by 0.93% in 2013 (and 1.69% in Q4 2013), with the company's full-year revenue decline due to continued weakness in its display advertising business. As Yahoo's management noted on the company's earnings call, the search business continues to perform well, with Q4 2013 marking the 8th consecutive quarter of revenue growth for the division on an ex-TAC basis. Although paid click growth decelerated by 400 basis points to 17% in Q4 2013 on a sequential basis, we note that Yahoo's 17% year-over-year growth in paid clicks during Q4 2013 marks a 400 basis point increase versus the company's Q4 2012 growth rate. With price-per-click falling by 3%, Yahoo posted 13% growth in its search click revenue, helping drive an almost 8% increase in ex-TAC search revenue during Q4 2013. This makes it clear that the revenue weakness at Yahoo is not broad-based, but rather confined mostly to its display business, which the company continues to invest in an attempt to stem its decline. And while there is much work ahead, early indicators suggest that Yahoo's efforts are beginning to bear fruit.
While display revenue ex-TAC fell by over 8.5% in 2013, revenues fell by less than 6% in the fourth quarter, and a burgeoning recovery appears to be underway, with progress seen throughout 2013. In the table below, we break down the growth of Yahoo's display business over the past five quarters:
Yahoo Display Business Growth
Number of Ads Sold
In Q4 2013, Yahoo once again posted positive year-over-year growth in the number of ads sold across its display network, with CFO Ken Goldman attributing the three sequential quarters of ad growth to new advertising formats across the company's various product offerings. Price per ad sold fell 7% due to a continued low percentage of ads sold on a premium basis. However, the company has laid the groundwork for a further recover in 2014, with meaningful investments in content. In early 2014, Yahoo inked a partnership with David Pogue, launching Yahoo Tech to offer users an original digital magazine, covering the technology industry. When David Pogue announced that he was leaving the New York Times, arguably the newspaper of record in the United States for Yahoo, many in the industry were puzzled, not only by the fact that he was leaving a paper that for most journalists represents the very pinnacle of their careers, but that he was leaving the New York Times for Yahoo, which few in the industry associate with innovation. In an interview with Forbes, Pogue offered a detailed explanation of why he chose to move to Yahoo, and his responses are telling in what they reveal about the transformation that has taken place at Yahoo under the tenure of Marissa Mayer.
Pogue noted that there were two reasons for his move to Yahoo. Pogue spent two full days at the company, meeting with executives and getting a sense of what the company was like, and in doing so, learned that 42% of Yahoo's current employees were not at the company when Marissa Mayer became CEO in July 2012. And second, Pogue described what he saw as a company with "a real start-up mentality and a fire in the bellies of employees that was palpable." Yahoo is no longer the dominant force in search and advertising that it once was. The company is now an underdog, with almost half of its employees joining after July 2012, and this has instilled a strong sense of fight into the company's employees. Employee morale is crucial in any turnaround, and from David Pogue's observations, it seems that employee morale at Yahoo is strong. In conjunction with Yahoo Tech, the company has also launched Yahoo Food, a 2nd digital magazine focused on recipes and food trends. Since their launch in January, these two magazines have amassed over 10 million unique users, and we expect further user growth to be reported when Yahoo reports its Q1 2014 results, as well as continued stabilization in the company's display business. Crucially, underlying traffic across Yahoo's various properties has begun to recover, driven by both Tumblr, which the company acquired in 2013, as well as at its core properties. CEO Marissa Mayer noted on the company's earnings call that since June 2013, Yahoo has posted growth in traffic to its properties, with growth continuing in Q1 2014 on a year-over-year basis. Of note is the growth in Tumblr users and traffic. As of January 28 (the date of Yahoo's Q4 earnings call), time spent on Tumblr has surged by 50% year-over-year and mobile postings have grown by 200%, significantly outperforming growth in total postings, which have risen by 40% year-over-year. Tumblr's user base has grown by 30% since March 2013, and mobile users have increased by 50%. To capitalize on this growth, Yahoo has launched an overhauled advertising platform for Tumblr, dubbed Sponsored Posts Powered by Yahoo Advertising. Companies seeking to advertise on Tumblr will now be able to target ads based on both gender and location, and will pay when their ads elicit explicit actions from Tumblr users (reblogs, follows, and likes). In conjunction with this overhaul of Tumblr, Yahoo is also in the process of overhauling the ad experience on Flickr, with the goal of transforming its standard display ads into native advertisements. We expect more color on Tumblr and Flickr advertising when Yahoo reports its Q1 2014 results in April.
However, while Yahoo has begun to make progress in turning its business around, this progress has come at a price. Pro forma EBITDA fell by 6.01% in Q4 2013, with an almost 3% decline in operating income, with full-year EBITDA and operating income falling by an even larger 7.92% and 10.86% respectively. On an ex-TAC basis, both EBITDA and operating margins fell in Q4 and 2013, but the decision by CEO Marissa Mayer and CFO Ken Goldman to ramp up investments in Yahoo's future is the cause of this decline. Product development spending rose by over 14% in Q4 2013, and almost 14% in 2013 as a whole, as Yahoo ramps up spending on new products. When Marissa Mayer arrived at Yahoo in July 2012, the company had just 60 mobile engineers. As of the end of March, the company has nearly 400. Running in contrast to the narrative that Yahoo is no longer a desirable place to work, CEO Marissa Mayer noted that in 2013, Yahoo received over 340,000 job applications, more than double the amount the company received in 2012. She noted that 40% of the new employees hired by Yahoo in 2013 were engineers designed to enhance the company's ability to innovate and develop new products, across the desktop, the tablet, and the smartphone. An early result of this hiring surge is the overhauled Yahoo Mail iOS and Android app, which has driven a 150% increase in daily active users since its overhaul in early 2014. These investments, while serving to pressure EBITDA and operating income, have begun to yield dividends. Management noted that in aggregate, Yahoo's mobile, social, and video, and native advertising revenues businesses grew by 60% year-over-year in 2013, and while these businesses currently comprise a small portion of Yahoo's overall revenue, we expect them to play a more meaningful role with each passing quarter, with more color on their performance in April, when Yahoo reports Q1 results.
Yahoo's guidance for Q1 2014, released in conjunction with its Q4 2013 earnings calls for these investments to continue, as Yahoo maintains its pace of hiring and technology investments. Revenue ex-TAC is forecast to come in within a range of $1.06 to $1.1 billion. At the midpoint of Yahoo's guidance range, this implies consolidated year-over-year revenue growth of 0.53%. We note that on a full-year basis, Yahoo is projected to return to revenue growth in 2014, with consolidated revenues ex-TAC rising by 1.52%. More notable is the consensus forecast for 2015 revenues, which calls for revenue growth to accelerate to 3%. However, Yahoo's EBITDA and operating income guidance has unnerved some investors, and we detail the company's guidance in the table below (figures provided will be at the midpoint of Yahoo's guidance range).
Yahoo Q1 2014 Guidance (in Thousands of $)
EBITDA Margin ex-TAC
Operating Margin ex-TAC
The company is forecasting pro forma operating income to come in at $130-$170 million; at the midpoint, this implies a 32.89% decline in operating income, as well as a decline in operating margins from 20.81% to 13.89%. CFO Ken Goldman notes that operating expenses, which have historically declined from Q4 to Q1 on a sequential basis, will remain at a "steady state" in Q1 2014, as well as most of the year. CEO Marissa Mayer reiterated that Yahoo is set to continue to expand its talent base via more acquisitions in 2014, as well as focus on acquisitions that can enhance its capabilities and offerings in search, communications, digital magazines, and Flickr. While these investments are putting pressure on EBITDA and operating income, we believe that they are fully necessary to turn around Yahoo's performance and position it for long-term relevance and success in an increasingly mobile world. CEO Marissa Mayer has, in our view, demonstrated a clear grasp of the fundamental issues that afflict Yahoo, and has taken clear action to rectify them, and while 2014 will be a year of continued investment, we expect acceleration in signs that these investments are beginning to yield dividends for Yahoo. And as Yahoo continues to demonstrate that its core business is recovering, and as Alibaba completes its IPO, we believe that investor focus will shift away from utilizing Yahoo as a trading vehicle through which to gain exposure to Alibaba to the company's underlying business, which by that point is likely to show more and more signs of recovery. And when it does, we believe that a re-valuation of Yahoo's core business will be in order, which remains valued at levels far below its search and advertising peers.
Valuing Yahoo's Core
We believe that the best way to value Yahoo's core business is on a price-to-cash flow basis. Per Yahoo's latest 10-K, the company generated $1.18 per share in operating cash flow. As we mentioned earlier in this article, Yahoo's core business is currently valued at $1.93 per share, giving the company an underlying price-to-operating cash flow multiple of just 1.64x, far below its peers, which we define as Google, Microsoft, AOL, and IACI/InterActive. In the table below, we break down the price-to-operating cash flow (P/OCF) multiples of Yahoo and its peers, based on each company's March 28 closing price (net of cash) (note: trailing 12-month cash flow for Microsoft was created via a reconciliation of its latest 10-Q and its fiscal 2013 10-K, given the fact that its fiscal year ends in June).
Yahoo Peer Comparison
Net Cash (Debt)
Net Cash (Debt) per Share
Adjusted Share Price
TTM Operating Cash Flow
TTM Operating Cash Flow Margin
TTM Operating Cash Flow per Share
Price-to-Operating Cash Flow
Although the table below states that Yahoo trades at a P/OCF multiple of 27.07, this figure is significantly distorted by the company's equity stakes in Alibaba and Yahoo Japan. Of note is the fact that Yahoo's trailing 12-month operating cash flow margin is above its peer average of 23.08%, a level that is inflated by Microsoft, whose business (due to its software nature) is able to structurally generate higher operating cash flow margins than Yahoo's other peers. With Yahoo's peers trading at an average P/OCF multiple of 12.58x (excluding cash), this yields a value of $14.84 for Yahoo's core business when applied to Yahoo's trailing 12-month operating cash flow.
But what of 2014 cash flow? Critics of Yahoo will point to the company's Q1 EBITDA guidance as a sign that cash flow in 2014 will decline. To account for this, we will base our value on 2014 figures. Current consensus forecasts call for 2014 EBITDA of $1.421 billion (a decline of 9.16% versus 2013), and with Yahoo's 2013 operating cash flow equaling 76.41% of EBITDA, we arrive at estimated 2014 operating cash flow of $1,085,792,818 or $1.07 per share (based on Yahoo's currently outstanding shares). Applying the 12.58x P/OCF multiple described above yields a more conservative price target of $13.46 for Yahoo's core business. When this estimate of the value of Yahoo's core business is added to its stakes in Alibaba, Yahoo Japan, and its net cash, it yields a pro forma price target of $47.43 for Yahoo as a whole, which implies upside of 32.12% for the company's shares, based on their March 28 closing price of $35.90.
Yahoo's underlying business, despite producing well over $1 billion in operating cash flow on an annual basis, is being valued almost as if it is contributing nothing to Yahoo. Under the tenure of CEO Marissa Mayer and CFO Ken Goldman, the company has begun to show signs of a turnaround in its performance. The company is set to return to revenue growth in 2014 as the company's myriad of investments begin to yield dividends. The Yahoo of 2014 is a different company than when Marissa Mayer took the helm in July 2012, and as Alibaba moves closer and closer towards its IPO and eventually begins trading, we believe that the spotlight will shift away from Alibaba and onto Yahoo's core business. And when it does, we suspect that investors will be pleased with what they see. Although Yahoo has a long road ahead in returning its business to historical levels, the company is on the right path, and in our view, Yahoo will deliver further progress as 2014 progresses. And as it does, shareholders are likely to see further gains as the true value of Yahoo's underlying business emerges.
Disclosure: I am long YHOO, SFTBY, AOL, MSFT, IACI. 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.