Why Yahoo Is Still Going To $50 Per Share

Jul. 7.14 | About: Yahoo! Inc. (YHOO)


Analysts continue to underestimate the significant impact that Alibaba will have on Yahoo shares.

CEO Mayer has provided investors some clarity on where she intends to focus the Alibaba proceeds to further Yahoo's growth.

Post the Alibaba IPO, Yahoo's book value alone will be pushing the mid-$40 per share.

About two months ago, I wrote an article entitled 'Why Yahoo is going to $50 per Share.' When the article was published, the stock was trading for around $36.50 per share. Since then stock has experienced a fair amount of volatility, trading all the way down to $33.25 per share just two weeks ago. The stock has hence recovered a bit trading back up to around the $36 level, but that is still a far cry from the $50 per share I predicted.

For those that have been hiding under a rock for the last year, Alibaba Group Holdings Ltd. the giant Chinese online retailer is set to go public later this summer with an estimated valuation from $170 to $220 billion. Yahoo (NASDAQ:YHOO) currently owns a 24% stake in the soon to be public company. This investment post IPO could yield the firm around $47 billion (24% of an average IPO price of $195 billion) in pre-tax earnings. This is a much needed capital infusion for the struggling internet company as it looks for ways to set itself apart from major competitors like Microsoft (NASDAQ:MSFT), Google (GOOG, GOOGL), AOL (NYSE:AOL), and SINA Corp (NASDAQ:SINA).

Given the large ownership stake in the firm any news coming out of Alibaba (good or bad) can cause Yahoo stock to aggressively swing up and down. In the past month Alibaba valuations have come under some pressure. When Alibaba reported its fourth quarter numbers, revenue lagged and margins decreased. The quarter showed that sales for the firm had increased 39% through March. This was still down 32% from the year prior where growth had reached a high of 71%. Profit margins also declined to 45% down from 51% the year prior. After this news hit the wire, Yahoo stock dropped 5.5% in a single trading day with no significant negative news directly related to Yahoo itself. This price action further emphasized the importance and impact of the upcoming Alibaba IPO on Yahoo stock.

After the August IPO, Yahoo has stated that it plans to sell off around 40% of its total Alibaba position. This then leaves investors asking themselves what CEO Marissa Mayer will do with all of that money. During Yahoo's most recent earnings announcement, Mayer made it a point to highlight the firm's growing mobile business segment which I would guess is where she sees the future of the business is heading. During the call Mayer highlighted the 7.5% increase in online mobile apps between the 4th quarter and 1st quarter. Mayer has highlighted during the quarter that growth will come from four areas: search, communications, digital magazines, and video. Additionally, total display ads for the firm increased by 7% in the first quarter alone, another area where Mayer sees future growth for the company.

Even amongst all of the upbeat news coming out of Yahoo and the strong anticipated Alibaba valuation, analysts continue to remain neutral to negative on the Yahoo's future performance. This was further emphasized this past week when Evercore Partners suspended coverage on Yahoo until after the Alibaba IPO when more information on valuation is available. That being said, bucking the overwhelmingly neutral stance amongst analysts is Piper Jaffrey who has increased its weighting to overweight from neutral estimating a $43 price target.

Even amongst all of the negative/neutral sentiment I remain very bullish on the stock. Aside from Mayer's plans with her newfound cash infusion I like Yahoo simply from a valuation standpoint. Currently, Yahoo has a book value of around $12.77 per share. Assuming that post the Alibaba IPO Yahoo is able to generate $47 billion in pre-tax income and assuming a 35% corporate tax rate, Yahoo would generate $30.5 billion in post-tax cash. When that new cash is added to the balance sheet it would increase the firm's overall equity to $43.27 billion and push up the overall book value of Yahoo to $42.84 per share, all things being equal.

That math is assuming that a net cash value of the entire ownership position on day of IPO. Given that Yahoo has already indicated that they only intend to sell 40% of its stake indicating that there is a chance that as Alibaba appreciates in value that the overall balance sheet impact for Yahoo could be even higher. With 60% of Yahoo's position remaining in stock and given that fact that I believe Alibaba will continue to appreciate in value post its IPO, I think the overall impact on Yahoo's stock could be more than most analysts' think, ultimately pushing the stock up towards $50 per share.

To put it more simply, for every $5 billion in additional market value that is added to Alibaba's base value basically equates to an additional $1 in book value being added to Yahoo. Given that and knowing that with all of the hype around the Alibaba IPO I think that it is highly likely that Alibaba will continue to appreciate in value between its IPO date and the end of the year, ultimately adding additional value for Yahoo shareholders.

I know I seem overly bullish on this upcoming IPO, but the numbers don't lie and I continue to believe that the market is underestimating the impact that Alibaba is going to have on Yahoo's stock. It does make me feel better that even CEO Marissa Mayer is sleeping well at night leading up to the anticipated IPO. About 3 weeks ago, Mayer inadvertently over slept when on the road with advertisement executives causing her to be late to several meetings. If the company CEO is sleeping well at night leading up to the Alibaba IPO, then I guess I will follow suit.

Disclosure: The author is long YHOO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.