Yahoo (YHOO) investors are lucky to have an advocate in the stock's largest outside owner, Third Point LLC. This activist investment firm is currently challenging the board and executives of Yahoo over alleged misrepresentations in the resumes of CEO Scott Thompson and director Patti Hart.
Third Point's CEO, Daniel Loeb, is correct to confront Yahoo leadership on this scandal based on its own merit and also as an opportunity to assert shareholder interests over the in Yahoo's future. Individual investors and fund managers who either have few votes or lack the time to exercise their voting rights are fortunate that activist investors like Third Point are reviewing the management of companies like Yahoo. Stocks which are scrutinized by activist investors are more likely to achieve their potential values than relying on managerial inertia.
A Weekend Ultimatum
On Friday, May 4th, Third Point LLC sent a letter to the Yahoo board of directors demanding an investigation into the credentials of CEO Thompson and Director Hart. The terms of the investigation were laid out explicitly and include publicly releasing documentation of the CEO vetting process and any ties between Yahoo's directors and its chosen CEO. Third Point's letter also specified that this investigation resulting information was to be released by the following Monday, May 7th.
Daniel Loeb's letter elaborates on the damages which would result from inaction in light of this scandal:
Irreparable damage to Yahoo's culture will continue every day that the Board allows Mr. Thompson and Ms. Hart to remain at the helm of the Company after having clearly demonstrated that they lack even the "minimum qualifications for service as a director of the Company." Mr. Thompson, in particular, cannot possibly have any credibility remaining with the all-important Yahoo engineers, many of which earned real - not invented - degrees in computer science. Moreover, permitting Mr. Thompson and Ms. Hart to stay with the Company after apparently violating the Code of Ethics sends a message to all Yahoo employees that a different set of rules applies at the top.
Investors should be cheering that someone - anyone - is checking the references of the recipients of million dollar contracts. Mr. Thompson's compensation package for 2012 was likely to be $27 million, a compensation package which should never have been awarded without the utmost scrutiny. The possibility that such a large contract would receive less scrutiny than is involved in the typical hiring process is infuriating.
The Saga Continues
Since the May 7th deadline came and went, Third Point LLC has initiated the legal process to obtain records related to the executive search process that hired Mr. Thompson. As this story unfolds the price of Yahoo stock will likely become more volatile, affording investors with opportunities to buy at lower prices.
Though the short-term price fluctuations are regrettable, in the long run these events will likely benefit Yahoo investors. As a business Yahoo has been directionless and has stagnated for years. Its US web properties are something of a missing link between AOL (AOL) and Google (GOOG). Yahoo also owns many non-core assets whose values could be realized through spin-offs and sales to outside investors, a strategy which only recently has been considered by Yahoo leadership.
Yahoo's stock 1.5 price-to-book ratio, 17.5 price-to-earnings ratio, and 3.77 price-to-sales ratio are deceptively ordinary. These ratios fail to reflect the sum-of-parts valuation of the company. Today, there appear to be many refreshing oases in the Yahoo value desert. Yahoo owns about 40% of Alibaba, which was valued at $32 billion last year. Today, analysts anticipate that Yahoo's 40% stake is worth more than the $12.8 billion implied by last year's valuation.
Similarly, Yahoo's 35% stake in Yahoo Japan is said to have an $8 billion market value. Ownership in these two Asian web properties amount to $20.8 billion. Since Yahoo is currently trading at a $18.8 market capitalization and has $2.2 billion in debt, all of Yahoo's other assets are basically trading for free based Yahoo's $15/share market price. (This analysis ignores taxes from such sales, though it also ignores tax-avoidance strategies like acquiring other firms with overseas tax-losses.)
Shareholder Activism vs. Management Control
Loeb and other activists are boons for investors who hope deals like these will materialize to unlock the value of the Yahoo portfolio. In contrast, many other firms deprive outside investors from having a voice in the firm's management. One salient example is Google, which is explicitly controlled by insiders. Larry Page, Sergey Brin, and Eric Schmidt control 66% of existing voting rights based on their ownership of Class B shares with enhanced voting rights. Even as a unified block, outside investors have no means to challenge the direction of Larry, Sergey, and Eric.
Third Point LLC owns 11.22% of Xerium Technologies (XRM). This disposable paper product company trades at a bargain 7.69 price-to-earnings multiple and a cheap 0.11 price-to-sales ratio. In 2011 Xerium shares traded as high as $25 but now trade near $4. Third Point's influence may bully a meaningful change in leadership and alter this trend.
Third Point LLC also exerts influence over MGIC Investment (MTG) based on its 2.49% ownership. This stock has suffered in the mortgage fallout and currently trades near $3.20, dramatically lower than pre-crisis $70/share prices. The firm's 0.58 price-to-book multiple and the stewardship investors including Loeb and Kyle Bass (Hayman Capital Management owns 4.97% of outstanding MTG shares) bode well for value investors.
Though these holdings are interesting, Yahoo remains the best way to play shareholder activism. Its on-again, off-again talks regarding selling its Asian assets and the large holdings and influence of Third Point suggest that a reorganization of the firm and an investor-payoff are only a matter of time and arm-twisting. How will this impact the stock? I expect new highs will be reached once Yahoo gets turned around.