It seems like ages ago that the technology bubble was bursting. The housing bubble formation and bust that happened subsequently have almost erased the tech bubble from my memory. I suppose that's because if you were a value investor, you were able to escape most of the carnage of the tech bubble as stocks with reasonable valuations didn’t fare too badly. The stock market panic created in 2008 by the housing collapse spared few as stocks of all kinds plummeted.
Could you have imagined in 2000 showing investors what would happen to the stock prices of some of the big tech players over the next 11 years? The big tech companies themselves have done pretty well from a business standpoint. But consider their stock prices:
) stock price in December 1999: $58; in September 2011: $25.
) stock price in December 1999: $41; in September 2011: $20.
) stock price in December 1999: $53; in September 2011: $16.
) stock price in December 1999: $108; in September 2011: $14.
If there was ever a perfect case study for the importance of valuation in equity investing this decade for this group of companies, this is it. The good news for shareholders of these companies is that the stock price declines combined with a decade of business growth means that they are finally starting to look attractive from a valuation standpoint, and we are starting to see some smart money take an interest in some of them.
The Vultures Started to Circle Yahoo
If you follow Yahoo as an investing opportunity, you will have seen the letter
filed with the SEC by hedge fund Third Point LLC. Third Point, which has $8 billion under management, is run by hedge fund manager Dan Loeb. Loeb and Third Point have acquired a 5.1% interest in Yahoo, making them the third largest shareholders -- and they're demanding some change.
Loeb has two main beefs with the Yahoo board of directors:
It is now widely accepted that the Board made a serious misjudgment in approving the hiring of Carol Bartz as Yahoo’s Chief Executive Officer, given her inexperience in the consumer-oriented internet space. Although we are pleased that the Board has terminated Ms. Bartz’s employment, we fail to understand why this decision was so long in coming given her abysmal performance over the last two and a half years.
It is also now widely recognized that the Board made a gross error in turning down the $31 per share Microsoft bid in 2008, which would have generated significant returns for Yahoo’s shareholders.
Loeb isn’t pulling any punches as he is demanding that the current board of directors step down and be replaced with an “all star” team of director candidates that he has assembled. Clearly Loeb thinks that the value of Yahoo’s business is greater than the current valuation assigned by the stock market. In the letter, he breaks down his thoughts on valuation, which I’ve summarized below.
Value of Yahoo: $2.49 per share in tax adjusted cash; $3.10 per share in after tax value for Yahoo’s interest in Yahoo Japan; $5.24 per share in after tax value for Yahoo’s interest in Alibaba Group (OTC:ALBCF
). These three easy to value parts equal $10.83. With a share price around $14, that leaves just over $3 per share of value being assigned to the core Yahoo business. That is just over two times the core Yahoo EBITA expected for 2012.
Loeb thinks an appropriate EBITDA multiple for the core Yahoo business would be 7X, which would suggest he thinks Yahoo as a whole is worth:
Core business value (7 x $1.26) = $8.84
Tax Adjusted Cash = $2.49
Yahoo Japan = $3.10
Alibaba Group = $5.24
Total valuation estimate = $19.68
Loeb also believes another $3-4 of value could be gained if the Asian assets are monetized in a more tax efficient manner than he has modeled and believes better management could increase the value of all parts of Yahoo.
Why Einhorn Threw In The Towel So Quickly
Earlier in the year, David Einhorn, another closely watched hedge fund manager, originated a position in Yahoo. Like Loeb, Einhorn thought the sum
of the parts valuation exceeded its stock price.
YHOO currently has $3 per share of net cash on its balance sheet and has approximately another $8 per share of value in its two minority equity stakes of publicly traded companies in Asia (Yahoo Japan and Alibaba.com). Assigning a conservative valuation (5x current year EBITDA) implies $18 per share for just the core businesses and the publicly traded securities and cash. We believe that Yahoo’s most valuable asset is its 40% stake in Alibaba Group’s still-private holdings, which are separate and distinct from its ownership in the publicly-traded Alibaba.com, which we are essentially getting for free. Among Alibaba Group’s privately held Chinese internet assets is a company called Taobao, which is the leading eCommerce website in China. More merchandise was sold on Taobao last year than on eBay, and Taobao's merchandise sales are growing 100% annually. We would not be surprised if YHOO's 40% stake in Alibaba Group alone was ultimately worth YHOO's entire current market value. YHOO stock ended the quarter at $16.68 per share.
The valuation work of both Loeb and Einhorn are virtually identical. Why then did Einhorn turn around and sell his Yahoo position in the second quarter at a small loss? He lost confidence in the value of the Asian assets as the CEO of a Chinese unit “hived-off” a valuable subsidiary into a corporation he personally controls. Loeb is obviously aware of these concerns over the Asian assets, as they are a critical portion of Yahoo’s value. Loeb places the blame for the issues with these assets squarely on management and addresses this.
Finally, the company’s leadership needs to rebuild relationships with its valued Asian partners in Yahoo Japan, Softbank (SFTBK.PK) and the Alibaba Group. These are important sources of value for Yahoo, and the company needs to enter a new, constructive era with these critical allies and friends of the company.
Getting the issues in Asia worked out must be a crucial part of Loeb’s investment thesis.
Plenty of Fish in The Sea
The sum of the parts valuation isn’t hard to follow, but I’m not sure I understand why taking this on for Loeb or Einhorn is worth the effort. With a stock price of $14 and a valuation that might not even reach $20, the upside doesn’t seem much greater to me for Yahoo than it is for Microsoft, Dell (NASDAQ:DELL
) or other less troubled alternatives. I suppose there could be a lot more upside if new management could dramatically improve the core operating business of Yahoo. But as Warren Edward Buffett says, “I don’t do turnarounds because they seldom turn."
I think the high profile nature of taking on a company like Yahoo makes it extra attractive for the likes of Loeb. He might not be as interested in a lesser name with a similar upside. For me, I think I can do better elsewhere and will take a pass.
I am long DELL