A Granular Look At The Yahoo Core

| About: Yahoo! Inc. (YHOO)

Summary

The Core Yahoo is not just an operating company, it owns several cash flow streams, real estate assets and IP.

Given the Core Yahoo's assortment of different assets, I believe a more granular look than the standard acquisition analysis is warranted.

It's clear that the company is undervalued, so long as the sale of the business does not trigger a tax liability on the Asian assets.

Introduction

In this article, I aim to present a more granular analysis of what Yahoo (NASDAQ: YHOO) is worth, in particular the "Core." Most analysts and commentators have been valuing the Core (defined in this article as everything the company owns excluding its stakes in Yahoo Japan and Alibaba) using a very simplistic EBITDA analysis. This may have been sensible if the company had simply completed its spin-off of its Alibaba (NYSE:BABA) stake. However, the Core today is actually a grab-bag of different assets. Given that it will sell itself to bidders that may be interested in different pieces, it's worthwhile to look at each in a more detailed manner.

The Operating Company ("OpCo")

To begin with, I do not see the Core as just an operating business. It is a collection of an OpCo, a patent portfolio, a holder of valuable real estate, as well as the owner of various different non-operating revenue streams. Let's begin with the OpCo and figure out its "true" earnings power. The headwinds the operating company is facing are well documented, so I will not address them in this article. I'm simply trying to figure out what it might be worth in a potential transaction. While the "Core" generated $950M in adjusted EBITDA last year (2015), much of this was not applicable to the OpCo. The company consolidates royalty revenues from Yahoo Japan, revenues from a revenue-share agreement with the company (which terminates in 2017), IP licensing fees, and a licensing agreement with Alibaba (TIPLA) into this figure. Breaking those out to view the genuine "Operating" EBITDA yields the following result:

Value ($M)

YHOO 2015 Adjusted EBITDA

950

Less:

Yahoo Japan Royalty Fees

90

Japan Japan Revenue Share Fees

140

IP Licensing Fees

88

TIPLA

199

Operating EBITDA

433

Multiple

5.5

Value of Core Operations

2381.5

Click to enlarge

The company only did $433M of EBITDA in 2015, and at a 5.5X multiple should be worth $2.38B at least. Remember that AOL was purchased for 7.5X, so a two-turn discount should be appropriately conservative. This is consistent with reports that some bidders have bid in the range of $2.5-3B for the "Core." It seems the "Core" in this case only includes the OpCo, whereas this article defines it differently. The company's real estate, patents, Yahoo Japan royalty stream, etc., obviously have some value so it is difficult to imagine that a sale to a strategic or private equity firm would give those assets for free.

The Remaining "Core" Assets

In 2015, the company generated $90M in Yahoo Japan Royalties. This is essentially a 100% margin, growing dividend that I believe deserves to be capitalized at a high multiple. Assuming a 25X multiple (4% yield) and 35% tax rate, this would be capitalized at 16.25X. Given that these are foreign profits, they could be used more tax efficiently; but for the sake of conservatism, let's assume they are only worth 16.25X. I do want to be clear that there are circumstances under which this royalty could disappear. Namely, these are:

  • Mutual decision by the companies to terminate the agreement;
  • Cancellation of the agreement following bankruptcy or loan default by one of the companies;
  • Purchase of one third or more of the company's outstanding shares by a competitor of Yahoo;
  • Merger or acquisition rendering Yahoo and Softbank incapable of maintaining over 50% of shareholder voting rights of the company (may be waived by agreement of Yahoo).

Of course, the first two are highly unlikely. The third also is unlikely as it's doubtful that SoftBank will dilute its stake in the company. Given that Yahoo is trying to divest its stake in Yahoo Japan tax efficiently, it seems unlikely that it would sell its stake. This would ensure that a purchase of such a sizeable stake (by a competitor no less) would be functionally impossible. Lastly, for similar reasons, it's difficult to imagine a scenario in which SoftBank and Yahoo lose majority control of the company and thus have their agreement breached. Given that the dividend is safe, and that it will likely grow in the future, I feel my valuation is conservative enough.

As concerns the other assets: the revenue share agreement will terminate in August 2017, so a 1.5X multiple was used. Tumblr is difficult to value, as the company gives very little disclosure outside of the fact that it did not meet its $100M revenue target for 2015. Analysts are estimating that it generated $75M in revenue and a 2X multiple gets us to $150M. Now this is a rough approximation, but given the currently elevated private market valuations in the social media space and the fact that the company purchased it for $1B, I believe an 85% discount is conservative. The patents and real estate also are difficult to value. This valuation assumes a 6X multiple on their licensing fees and a $1B valuation on their real estate. For reference, Starboard had assumed a $1.7B valuation for the two combined, compared to my $1.53B. Yahoo records its real estate $1.55B alone AFTER depreciation, so its true market value may well be in excess of that. Even assuming a zero cost basis for the real estate (which is obviously not true) and a full 35% tax rate, one would arrive at real estate value of $1.08B.

Cash Flow ($M)

Multiple

Value ($M)

Yahoo Japan Royalty Fees

90

16.25

1462.5

Yahoo Japan Revenue Share Fees

140

1.5

210

Tumblr

150

NOLs

150

IP Licensing Fee

88

6

528

Real Estate

1000

3500.5

Click to enlarge

After summing the value of these assets, we arrive at a value of $6.20 per YHOO share for the 'Core' assets.

SOTP

$5882B

Per Share

6.20

Click to enlarge

Concluding Thoughts

When YHOO sells their Core they will undoubtedly generate some taxable gain. The company's basis in itself is probably not zero, so I do not have the information to analyze what the final after-tax value will be. Yet, it's clear that as long as the company can divest the Core and not generate tax liabilities on its publicly held stakes, YHOO stock is worth substantially more than its current price. See the following table:

Per YHOO Sh.

Core

6.20

Net Cash

5.46

Yahoo Japan Stake (8% HoldCo Discount)

8.96

Alibaba Stake (8% HoldCo Discount)

29.21

SOTP

49.83

Click to enlarge

As long as YHOO does trigger tax liabilities on its equity stakes and remains as a HoldCo for them, the current price does not make any sense. Even if the Core is worthless, YHOO should trade for $43.63 (SOTP-Core in the above table). Since this article has addressed its positive worth, it is obvious that YHOO is an attractive risk-reward. More enterprising investors can hedge by shorting BABA, and this is in fact what I would recommend (be careful to leave some discount for the fact that Yahoo's ownership of BABA will be valued at a discount).

Disclosure: I am/we are long YHOO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.