Yahoo Cut to Sell Based on Valuation

Brian Bolan, research analyst at Jackson Securities, sent a note to clients cutting his Yahoo (YHOO) rating to 'sell'. Key excerpts follow:

Company Description

Yahoo! is an internet search and technology platform for all media that has established itself as the leader in its growing market. Yahoo! has transition to more than just a search engine to become a destination site and platform for new media delivery.

Valuation and Recommendation

Speculation has driven the price of Yahoo! up significantly prompting us to suggest that investors take action. A New York Post article suggested that Microsoft (MSFT) has entered into talks with Yahoo! about a potential merger. We don’t doubt that talks might be held, just the outcome is not likely going to be a positive one for shareholders of Yahoo!. We see this as an opportunity to reduce exposure to a stock that is overvalued and just had its earnings estimates cut.

Yahoo! going Soft?

Yahoo! saw its stock surge Friday morning based on speculation that Microsoft was looking to purchase the company. The rumor started in the newsroom of the New York Post, not exactly the epicenter of financial news and rumors. We believe that this is not likely to occur in the near term and advise that investors and holders of Yahoo! stock sell into the strength of the speculation, with hopes of re-establishing a position at a lower price.

New York Post

Over the last several months we can recall several instances of rumors originating from the New York Post. Rumors and speculation often hold a kernel of truth, as this one may well hold just that, but is not likely to be true.

When we look back at how Google (GOOG) bought YouTube, we see how a story would be leaked. A source calls the Wall Street Journal, not The Post, and gives some details on a deal. The key in this process is that it is the Wall Street Journal, or the Bible as some call it, and that there are some details that should make for a foundation for the story.

DoubleClick seen as a reason

The article in question notes that the Google acquisition of DoubleClick for $3.1B is one of the factors that is pushing Microsoft into an acquisition of Yahoo!. We question how a $3.1B acquisition will force a $50B+ acquisition, the math simply doesn’t work. While the DoubleClick deal doesn’t help Microsoft, there are other players that could be more suitable partners. 24/7 Media was earlier this week rumored to be the Microsoft dance partner, and its likely only a matter of time before several other names in the space are kicked around in the same vein.

Calling it quits

Should Yahoo! decide to pursue talks with Microsoft it would be a crushing blow to employees that have strained and struggles to get a beleaguered Project Panama off the ground. With only a few months of results under their belt, a sell at this time would be only a signal of weakness from what is supposed to be a potential game changer for the company.

On the flip side, one would have to imagine that Google employees would be more or less emblazoned by such a development. Management at Google would likely use it to their advantage to drive more productivity from workers by nothing that two giants need to team up in order to take us on… it would be time to put up or shut up.

Yahoo! Management

After the most recent earnings miss, there could be another management shake up in the offing at Yahoo!. Factor in a somewhat surprising rumor and investors will now be keenly focused on the next step that management takes. It is customary for the company to not comment on rumors or speculation, but we believe that the next major announcement that comes from Semel et al will be the one that Wall Street will use as a scorecard.

Valuation

With the stock trading above $32 per share, we believe that the valuation has become stretched to a breaking point. When you factor in the idea that we just reduced estimates, the numbers really force us into this situation. We believe that Yahoo!, while a core internet holding is overvalued and can likely be reacquired in the near term for a significant discount to the current price.