- The Alibaba IPO is most likely to IPO at $150-$160 billion, which would generate around $37 billion in cash for Yahoo.
- The Alibaba IPO has the potential to add between $30-$38 per share in book value.
- Yahoo shares currently are not factoring in all of the upside potential of the Alibaba IPO, and are greatly undervalued at $35 per share.
Over the last several months, there has been a lot of hype and speculation centered on Yahoo (NASDAQ:YHOO) and its 24% ownership stake in Alibaba, the Chinese e-commerce company. Alibaba is slated to go public with an IPO later this year (August of 2014), and speculation around the anticipated valuation of the firm come its IPO have started to reach the point that I consider to be approaching irrational exuberance. I have read many posts and articles concerning this upcoming IPO, and have seen estimates ranching in value from $100 billion to the more outlandish $300 billion.
The hype around the upcoming IPO reminds me of the May 2012 Facebook (NASDAQ:FB) IPO that opened at a ridiculously high price of $38 per share, only to come crashing down to around $18 per share two months later. Now, I will contest that Facebook has hence recovered nicely from a fundamental standpoint and has rewarded longer-term shareholders well, even if it trades for 74 times earnings.
During Yahoo's most recent quarter, the firm shared information on Alibaba's financials, stating that revenue during the fourth quarter had increased by 66% compared to the prior year. In 2013, the firm posted a net income of $3.52 billion on revenues of $7.95 billion. This represented a significant increase from the year prior. Keep in mind that in 2012, Alibaba bought back half of the original Yahoo stake in the company valued at $7.6 billion, this expenditure obviously had a negative impact on overall revenues and earnings for the year.
Obviously, with the company still being private, it is hard to really dig into the financials, so until we get closer to the IPO, we will need to rely on the information that Yahoo has shared. To help determine a fair market estimate of what Alibaba might go public for, I have outlined below several assumptions that can be drawn upon to aid in determining this.
First, let's assume that the net income of $3.52 billion remains static. Next, we need to determine what I am going to coin as a standard "hyped-growth" multiple. To obtain this, I am going to lean a bit on some other publicly traded firms to help provide some general guidelines.
To get a balanced sample set, I think it is prudent to have a combination of a recent high-multiple IPO, the previously mentioned Facebook. Additionally, I feel that since this is a Chinese firm, we should also have some fellow Chinese companies as a benchmark. I am going to use SINA Corp. (NASDAQ:SINA) and Baidu (NASDAQ:BIDU). Lastly, looking back to the U.S. for more established technology giants who make money on both advertising and the selling of goods, I want to include Google Inc. (GOOG, GOOGL), Amazon (NASDAQ:AMZN), and eBay Inc. (NASDAQ:EBAY) within the sample set.
Below is a table that highlights what the anticipated valuation of Alibaba could be at the various multiples of the above mentioned firms.
Current Price / Earnings Ratio
Estimated Alibaba Valuation
Cash Value of Yahoo Ownership Stake
**Averages do not include Amazon metrics due to values being such an outlier from the peer group resulting in skewed numbers
As a side note, in no way do I think a $1.65 trillion IPO is even possible. If anything, it further highlights how outrageous Amazon's current valuation is.
In looking at all of the valuations that are listed above (excluding Amazon), the average valuation comes in at $160.61 billion. This valuation seems to mesh well with majority of the valuations that I would consider to be more reasonable, even if it is on more of the conservative side. Additionally, it is a valuation that I think makes sense given the general size of Alibaba and its growth potential going forward.
UBS (NYSE:UBS) currently has a $165 billion value on the Alibaba IPO and a price target of $47 for Yahoo. I reference the UBS price target because they are both current and seem to mesh the closest with my analysis. Now, for the purposes of this article, I am going to assume that the Alibaba IPO will end up at the $160 billion mark. Given that Yahoo currently has an ownership stake in the firm for around 24%, the IPO price would yield Yahoo $38.55 billion. Assuming that Yahoo sold its entire stake the day of IPO, after paying the 39.1% corporate tax would net Yahoo with $23.48 billion in cash on hand.
Now what the firm ultimately decides to do with this unforeseen cash is yet to be determined, but below, I have played out several scenarios as to why even given this uncertainly, the stock is greatly undervalued.
- Yahoo keeps the money on the balance sheet: Currently, Yahoo has about $8.3 billion in combined long-term investments and cash. Long-term debt currently sits at $1.125 billion. Reducing for the debt leaves puts the firm with a net cash reserve at $7.175 billion, or a per share value of $7.07. Factoring in the Alibaba proceeds would add $23.48 billion to the net $7.175 billion amount, increasing the net cash hoard to $30.65 billion. This would amount to a per share cash value of $30.22. An increase of $23.15 per share.
- Yahoo uses the money to buy back more stock: This one is a bit harder to calculate, knowing that whatever the IPO goes public at, the market would theoretically adjust for it in the price of Yahoo, making the overall impact of buying back shares less powerful. For simplicity purposes, let's just assume that post-IPO, the stock jumps to $40 per share, a 15.5% increase from today's price. The current outstanding share count sits at 1.014 billion shares. At $40 per share, the Alibaba proceeds ($23.15 billion) would be able to buy 564.63 million shares or reduce the current share count by over half, putting the new outstanding share count at 450 million shares outstanding.
Factoring in the existing $5 billion buy-back program that is already underway, I am going to assume an average purchase of $35 to factor in current purchases up to the IPO. Adjusting for this buyback would reduce the count by another 142.87 million shares, bringing the total count down to 306.5 million. All things remaining equal, Yahoo currently has a book value of $12.72 per share. After adjusting for the future state share reductions, the new book value would be $42.10 per share, an increase of $29.38.
- Yahoo doesn't sell any of its stake in Alibaba and keeps the investment on the books: Given this scenario, it is safe to assume that depending on where Yahoo puts the investment on the books, it will increase the overall equity position on the balance sheet. Currently, Yahoo has $12.905 billion in equity on the balance sheet. Given that this investment will most likely be accounted for on a mark-to-market basis, the full market value of the asset would be accounted for. Assuming the original $160.61 billion valuation, the market price of the asset would be set at a pre-tax basis of $38.55 billion. This would increase overall equity on the balance sheet by $51.455 billion. For simplicity purposes, I am going to ignore the existing $5 billion buyback that is currently going and just use the current share count to determine the future state book value. With $51.455 billion in equity, the new book value of Yahoo would increase from the current $12.72 to $50.72, a $38 increase from the existing book value price.
Out of the three possible scenarios that I have outlined above, I actually think a combination of the three is the most likely. Yahoo is going to want to sell some of its ownership stake to take some risk off of the table, and of course, reward patient shareholders who have been waiting and waiting for the Alibaba IPO. I think that Yahoo will sell a significant portion of the position and buy back additional shares. I also believe that Yahoo will want to add a bit to its cash war chest, so that it is ready for any market opportunities or potential acquisitions that should arise. I also believe that once Alibaba does go IPO, the stock will have a high probability of continuing to increase in value. Due to that, I think it would behoove Yahoo to maintain a certain ownership percentage in the firm to possibly sell at an even higher price down the road.
Regardless of what happens, the market currently is not factoring in any of the previously mentioned scenarios in the current pricing of Yahoo shares, and consequently, I believe that current valuations are extremely attractive, especially considering the potential upside that the shares could see later this year. Once the IPO occurs, I don't think it is unreasonable to believe that Yahoo shares will jump considerably, possibly pushing the $50 per share mark.