Yahoo: Is There Life Beyond The Alibaba IPO?

| About: Yahoo! Inc. (YHOO)

Summary

Yahoo's initial investment of $1 billion in equity of Alibaba in 2005 will soon IPO for over $100 billion.

As of March 2014, Yahoo had roughly 10.3% of the search-engine market share.

How can Yahoo leverage the success of Alibaba and continue to produce or acquire assets that will increase shareholder value?

About a decade ago, Yahoo (NASDAQ:YHOO) was a force to reckon with in the business of digital advertising, commanding sizeable market share in search engines. However, the company has been struggling to maintain a grip on the market with search engine giant Google (NASDAQ:GOOG), (NASDAQ:GOOGL) dictating the play in internet advertising.

To make the matters worse, the paradigm shift to social media advertising, largely thrust to the foray by the emergence of Facebook (NASDAQ:FB), has taken a huge chunk of digital advertising to social networks. As much as companies continue to use a search engine to promote their products, there is a new platform offering an alternative and particularly, a different kind of digital advertising.

Yahoo has also been facing rivalry from other internet players, including Microsoft (NASDAQ:MSFT) and tech start-up Pinterest, among others.

Yahoo can count itself lucky, or perhaps claim to have made one of the wisest decisions over the last ten years, when it invested $1 billion worth of equity ownership in 2005 in Chinese ecommerce giant Alibaba, then a start-up. Alibaba has since repurchased half of that ownership, leaving Yahoo with roughly 22.6%. This has so far proved to be one of the shrewdest investments made by the company, and now, seems set to usher in a new era at Yahoo. Shareholders are looking to see how the company will handle the influx from the Alibaba IPO.

Yahoo, whose core business involves delivering personalized digital media content to users in exchange of advertising revenue (search engine traffic, display ads etc.), has seen volatile trading in the last few months due to many factors.

These include - recent Q1 2014 results delivering 9th consecutive year-on-year growth in revenue (although by the lowest of margins) and a substantial decline in earnings; CEO Marissa Mayer's shopping spree for new start-ups ($1.21 billion spending in 2013 for 22 companies); and the upcoming IPO of Alibaba.com, in which Yahoo has a 22.6% stake.

Yahoo and Alibaba IPO

Currently, Yahoo has a market capitalization of about $34 billion. The company has been struggling to shore up revenues over the last few years, reporting little to no growth, despite the rapid growth in the digital platform market. In fact, some analysts are already assigning zero valuation to Yahoo's core business, which based on the value of its investments in equities, makes perfect sense.

Yahoo's Alibaba stake is valued at about $26 billion, based on the Chinese ecommerce giant's theoretical valuation of its shares in the IPO prospectus. Additionally, Yahoo Japan, which is another of Yahoo's equity investments, carries a value of about $9 billion. This means that both Alibaba and Yahoo Japan account for roughly $33 billion worth of Yahoo's market capitalization.

Therefore, the big question investors would be asking themselves is how much valuation does Yahoo's core business, which is a mainly digital advertising, command?

Now with the impending Alibaba IPO, which will see Yahoo offload about one third of its current holding in the Chinese ecommerce market leader, some investors are already asking questions about Yahoo's life after.

Alibaba, which has ~230 million monthly active users and is poised to expand further to capture 600 million internet users in China, is expected to raise ~$15-$20 billion from the IPO by selling about 12% of its ownership stake. In the process, Yahoo could receive ~$8-$9 billion in cash proceeds.

As of March 2014, Yahoo had roughly 10.3% of the search-engine market share in the U.S, while rivals Microsoft and Google hold 18.4% and 67.5% of the market respectively. This is quite embarrassing for Yahoo, which not long ago, was arguably the main threat to Google in the search engine market.

The impact of the declining market share has been evident in Yahoo's financial results, which have failed to rally up in tandem with industry growth. However, the company's focus on mobile content is beginning to shed some light on Yahoo's future with key milestones reported in recent results.

In first quarter 2014, Yahoo saw its revenue (excluding traffic acquisition costs) rise by just 1% to $1.08 billion, with search engine revenue growing 9% and display ad revenue growing by 2% year-on-year. The focus on mobile content is beginning to pay off, and the monthly active users increased to 430 million.

The company also introduced new content like Yahoo Food and Tech, partnered with Yelp (NYSE:YELP) and other internet players to improve existing content. However, since Apple (NASDAQ:AAPL) dropped Yahoo's weather App from its new iOS platform, the company must find a way to recouping the traffic that will be lost in the process. There are also fears that Yahoo's Finance app could be the next to follow in the fate of its counterpart weather app in the iOS 8 platform.

It is notable that Yahoo Finance and Yahoo weather are some of the main traffic drivers on Yahoo, and hence, losing out in the iOS 8 platforms could be a major setback in Yahoo's plans for boosting search engine traffic, and most importantly, penetration in mobile.

Yahoo must optimally utilize Cash from Alibaba IPO

Yahoo's most recent quarter profits edged lower by 20% to $311 million as restructuring costs soared. The EPS was down from $0.35 to $0.29 in Q1 2014. The company posted cash balance of $4.6 billion in March 2014 after spending $450 million in share repurchases.

Yahoo expects to receive a sizeable amount of cash following Alibaba IPO, and this should be useful in providing more liquidity for the company. This liquidity will certainly benefit Yahoo in developing new products, to acquire more emerging technology companies and to step up its fight against Google and Microsoft.

Reports suggest that, based on recent acquisitions, Yahoo's appetite for adding strategic start-ups could be set to soar, while at the same time, giving back some of the cash to investors.

There is no doubt that Yahoo could repurchase more shares from shareholders, given the fact that the company does not pay dividends. However, there are question marks on what type of acquisitions would be ideal for the company at this stage, especially in its bid to rebuild its search business.

CEO Marissa Mayer seems to be keen on strengthening Yahoo's social presence following the acquisition of Tumblr, and reports are now suggesting that Pinterest and SnapChat could be on the cards, as the company seeks to step up its campaign in mobile as well. Whether or not these types of acquisitions would revamp Yahoo's core business remains to be seen, but again, there is no certainty that the acquisition will take place.

Conclusion

Yahoo's share price has more than doubled since Mayer took charge about two years ago. However, much of that rally came last year, as the market responded positively to the company's share repurchases, and a more stable workforce, despite EPS declining from $3.26 in 2012 to $1.26 in 2013.

However, there is optimism that a reversal to this trend could happen in 2014, with expectations pegged at $1.35 earnings per share. In the event that the company authorizes more share buybacks, there is a chance that the company's stock price could rally further. However, for the long-term outlook, the amount reinvested in revamping the company's core business will be under microscope, as this is what will determine Yahoo's life beyond Alibaba.

In summary, CEO Marissa Mayer has been successful in turning around the company from its lows in 2012 and has communicated her focus on mobile content growth during the recent press release. However, Yahoo's prudent use of its fresh cash from Alibaba's stake sale will hold key to instilling investor confidence.

Disclosure: The author is long YHOO, FB. 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.