I am not writing to question your leadership and management of the Yahoo! web properties, as there are already enough sources applying pressure there, but rather I am going to question the management of Yahoo!’s assets and balance sheet. Also, I will outline a few possible ways to address the problems that I highlight and share my views as to why these measures are in the best interest of shareholders.
Yahoo! has a sizable portfolio of equity investments as well as cash and cash equivalents. The asset of greatest interest is your 33.43% equity stake in Yahoo! Japan, worth about $8.3 billion based on yesterday’s closing price. Based on our research and analysis, we believe your company’s shares are currently undervalued by at least 20%. We view the lack of financial visibility created by your stake in Yahoo! Japan as a cause of your stock’s underperformance. There are two ways that this problem can be quickly corrected.
The first solution would be to unload your stake in Yahoo! Japan. There is no better way to improve your company’s financial visibility. It would add over $8 billion in cash to your balance sheet, bringing Yahoo!’s total cash on hand to over $10 billion. There are countless ways that such an amount of cash could be utilized. Most effective though, based on our view of your business being at least 20% undervalued, would be to greatly reduce the amount of outstanding shares of Yahoo! through a massive tender offer.
Considering a modest 10% premium over the most recent closing price, about $29.00 per share, 25% of outstanding shares can be retired through such an offer. This will result in greatly improved financial ratios, which the market puts a great amount of emphasis on. Also, the reduction of assets and outstanding equity will result in significantly higher returns on both assets and equity.
Should you be adamant in maintaining a large position in Yahoo! Japan, we would like to see the stake upped to a level ranging between 51% and 54% of shares outstanding, preferably 54% to ensure that a majority stake is maintained even after share dilution stemming from future stock option grants.
The cost of acquiring an additional 20.57% stake in Yahoo! Japan, the amount needed to give your company 54% ownership, would be $5.1 billion based on Yahoo! Japan’s most recently quoted market price. For the purposes of this letter though, we will assume a cost of $5.5 billion, as a premium to the current market value will most likely have to be paid to acquire such a sizable position. As a direct result of becoming the owner of a majority stake in Yahoo! Japan, your company would instantly gain greater financial transparency and benefit from your assets rather than hide shareholder value within them. As majority owners, you would be able to include the results of Yahoo! Japan’s operations with your own, a move that would be extremely accretitive to both the top and bottom line.
In the past four quarters of operation, Yahoo! Japan has reported revenue of $1.68 billion, operating income of $812 million, and net income of $454 million. Including these figures with your own would boost your revenue by 17%, your operating income by 84%, and your net income by 62%. The impact this would have on your companies market value would be substantial. Based on all of the major valuation ratios, your companies shares should appreciate in value. As stated before though, such a deal would cost nearly $5.5 billion, which is much more than your available cash on hand. Given your $36 billion market cap, taking on a debt to equity ratio of just 0.1 would be enough to finance the remainder of the purchase.
While viewing the first proposed measure as the more favorable of the two, either of the two will result in greater visibility and greatly improved financial ratios, which will drive an appreciation in the value of Yahoo!’s shares. As CEO, it is your duty to generate returns for shareholders. Given this fact, both proposals should be immediately reviewed as they are in the interest of shareholders.
YHOO 1-yr. chart: