Of all the companies in our portfolio, few generate as much press coverage or drama as Yahoo! (YHOO). The internet and media company has been under the media microscope for months now, as drama over CEO succession, board management, and takeovers spills into the financial press. Yet, despite all this, Yahoo remains a compelling buy, for several reasons.
Normally, we cover a company's operational results and financials, presenting a case as to why the stock is undervalued. However, this article will not focus on that. The very public drama surrounding Yahoo! has all but guaranteed that a deal for the company will happen, and virtually no investors even care about the companies actual operational condition. But, should a deal not happen in the way Wall Street may want, we think Yahoo!'s assets and valuation will put a floor under the stock. Since the start of 2011, Yahoo! shares have fallen by 6.07%, compared to the S&P 500's largely flat performance.
However, going forward, we think Yahoo! shares will outperform, for the reasons below.
First and foremost, we think the shares will outperform due to a takeover of the company. Currently, there are several plans circulating around Wall Street. They are:
- Selling 20% to SIlver Lake, Microsoft (MSFT), and Andreessen Horowitz: This consortium, according to various media reports, has offered $16.60/share to buy 20% of Yahoo!. This equtes to upside of around 6.27% from current levels. This scenario presents Yahoo! with both opportunities and challenges. On the one hand, the company will gain the expertise of Anreeessen Horowitz, which has vast experience running tech companies, and could be the cure to Yahoo!'s ailing core businesses. However, Yahoo! would be giving up a significant amount of its control at a relatively low premium. This consortium is reported to demand a heavy say in the selection process for Yahoo!'s next CEO, and will most likely seek board seats.
- TPG Capital/Greylock: A sale of 20% to this consortium would bring in less prestigious investors than a sale to Silver Lake, Microsoft, and Andreessen Horowitz, but TPG & Greylock are said to have offered about a dollar more per share. Buying 20% of Yahoo! at $17.60, or a 12.7% premium, is a lot more tempting.
- Selling the entire company: The PIPE deals presented above will most likely not sit well with Yahoo! shareholders. And while they value the company at a premium to its current market value, it is not enough. Selling the whole company is a far better idea. Blackstone & Bain Capital are rumored to be preparing a bid for all of Yahoo!, valuing it at $25 billion, or $20.16 per share. That is a 29% premium, and is far superior to a private equity investment. These buyout firms are likely to partner with Alibaba ad Softbank, who have made no secret of their desire to buy back Yahoo!'s stakes in them. This deal presents 2 complications however. The first is financial. A follow up Reuters report highlighted the difficulty of securing debt financing for this leverage buyout. The loan market has shrunk, and investors are unwilling to support high multiples of leverage. That being said, Yahoo! still generates plenty of cash. Estimates call for EBITDA of $1.5 billion in 2012 and 2013. Potentially more complex is the political climate. Any deal involving Alibaba will be viewed with skepticism in Washington, for letting a Chinese company have access to the largest email provider in the United States may not be seen positively by regulators. However, we think a deal will be structured in a way that Alibaba gets control of its stake, not the core Yahoo! business. Further complicating matters is the Alibaba ownership structure, where selling Yahoo! could trigger a change in control, thus giving Alibaba and Softbank the right to buyback their stakes. Therefore, we view it as essential that they be involved in the deal from the outset, to maximize the value of Yahoo!'s Asian assets.
The amount of press coverage these deals have receives is unprecedented. It is as if all these negotiations are playing out in public. We think some sort of deal is all but certain. But should a deal not occur, the Asian assets Yahoo! holds should provide a floor to the stock. Below we breakdown the value of Yahoo!
|Asset||Value to Yahoo!||Value per Share|
|Alibaba Stake (40%)||$12.8 Billion||$10.32|
|Yahoo! Japan Stake||$6.4 Billion||$5.16|
|Total||$22.828682 Billion||$18.41||Notes: 1,239,719 shares outstanding|
Pre-tax, Yahoo!'s Asian assets, as well as its cash, are worth more than the company as a whole on its own. The implied value of Yahoo's Alibaba stake is $12.8 billion, based on the valuation Temasek assigned the company when it invested in it in September. Temasek valued Alibaba as a whole at $32 billion, and Yahoo!'s 40% stake is then worth $12.8 billion. Yahoo! Japan is worth around $6.4 billion. Media reports have stated numerous times that Yahoo! is looking to sell the stake back to Softbank at this price. To avoid a tax hit, the companies have looked at an asset swap, where Softbank takes Yahoo! stock in exchange for Yahoo! Japan stock, or the creation of a tracking stock for the Yahoo! Japan stake, thus allowing current shareholders to sell of the stake, all without a tax event. Yahoo! has $1,526,427,000 in cash, $1,357,661,000 in short-term investments, and $744,954,000 in long term securities, for a total value of $3,628,682,000. Yahoo!'s cash & securities, combined with its Asian assets, are worth almost 18% more than the entire company. We have assigned no value to Yahoo!'s core operations, since most investors in the stock see it as a holding company for its Asian investments. But Yahoo!'s core operations are solidly profitable, with the company earning 29 cents/share in the third quarter alone. The company has no debt, and has solid free cash flow, posting $246.714 million in free cash flow in the third quarter.
We freely admit that Yahoo! is nowhere near as efficient as Google (GOOG) or Baidu (BIDU), or its technology peers. But its US operations are still profitable, even if growth has stagnated. Yahoo! trades as if its US operations do not exist, and we think that is absurd. Valuing Yahoo's earnings at 1x for 2011 adds another 82 cents/share to its value. Despite what many people may think, Yahoo! is solidly profitable, and its core operations do have value, even if most investors do not recognize it.
Yahoo! is no doubt a company in transition. But interim CEO Tim Morse is already doing a far better job than any of Yahoo!'s 3 prior CEOs. He is facing a monumental challenge trying to turn around Yahoo!, and is faced with a difficult board. Yet, we think Yahoo! is a compelling investment at these levels. Some sort of deal for Yahoo! will happen, and even if it does not, Yahoo! is undervalued based on its assets alone. Analysts agree. Credit Suisse sees the stock at $19 and S&P rates it a strong buy with a target of $20. The Reuters average price target is currently $18.16, representing upside of 16.26% from current levels. Yahoo! is a company that is facing deep challenges, but they are challenges we think it will overcome. And we think that investors who have the patience and conviction to stick with the company will be rewarded.