Before closing, I'd also like to provide a quick update on our efforts to unlock the value of our investment in Yahoo! Japan. Over the last 6 months, we've explored a few different paths to achieve that objective, some have dead-ended and some have continued to evolve. Many of the structures we're pursuing are unique, so it's expected that some will prove nonviable. Our focus is to find the right solution and that effort remains a top priority of ours.
As of the market close on Friday July 22, Yahoo was trading at $13.98 per share. This represents a market capitalization of $17.8 billion and an enterprise value of $14.7 billion. Also as of Friday, July 22, Yahoo Japan had a market capitalization of $21.4 billion. This implies that Yahoo’s 35% ownership stake in Yahoo Japan is valued at $7.5 billion.
Investors want Yahoo management to be thoughtful with respect to the monetization of Yahoo Japan and to consider all options in an attempt to maximize shareholder value. However, there comes a time (more specifically, a valuation of Yahoo) that could suggest that the value maximizing course of action is to sell, incur the tax consequences, and buy back shares. The question is about comparing the tax leakage to the time value of waiting given the low level at which Yahoo is trading and the opportunity to use the proceeds at this low level to buy back shares.
If Yahoo sold its stake now, assuming a tax basis equal to the $1.85 billion ascribed to Yahoo Japan on Yahoo’s balance sheet (a 20% tax rate on the gain from the sale), 100% of the after tax proceeds will be used to buy back shares at a 10% premium to Yahoo’s current price, and if Yahoo holds its current 2011 earnings multiple of 18.1x consensus 2011 earnings, then the sale and buyback would result in over 51% EPS accretion.
However, It’s Not That Simple.
This would mean that the company is buying back almost one-third of the shares outstanding, which could require more than a 10% premium to the current price. More importantly, it is unclear how much of Yahoo’s current valuation is ascribed to Yahoo Japan versus Yahoo’s other assets including its core business, Alibaba.com, and Alibaba Group’s private businesses.
Any sum-of-the-parts valuation after a deal like this would no longer include Yahoo Japan (given that it will have been sold). If investors thinking about the value of Yahoo are mentally hair cutting the value of Yahoo Japan based on the tax leakage of a monetization, then this accretion could lead to an increase in the price of Yahoo’s stock.
However, if they are not, or if the actual leakage is worse versus their assumptions, then this could backfire and while there is accretion on a per share basis to Yahoo’s core business, the sum-of-the-parts without Yahoo Japan is less than the current market price. Put another way, there is a chance that the P/E does not hold and the analysis falls apart.
The conclusion here is that Yahoo’s management should be careful, consider all options, and try to minimize tax leakage while being cognizant that there is a time value component and investors would likely accept some tax leakage for a monetization sooner rather than later.