Over the weekend, Yahoo (YHOO) finally announced a deal with Alibaba (OTC:ALBCF) for the latter to repurchase part of the stake that Yahoo! owns. Under terms of the deal, Yahoo will sell up to half of its stake, or approximately 20% of Alibaba's fully diluted shares. The valuation on Alibaba shares will be no less than $35 billion (remember, Alibaba has not gone public yet). Yahoo will receive approximately $7.1 billion from the deal. Of that, at least $6.3 billion will come from cash and up to $800 million will come from newly-issued Alibaba preferred shares. A framework was also set for the future, regarding Alibaba repurchasing the other roughly 20% stake Yahoo has in the company.
Investors had been waiting for this deal for some time, and it is finally here. Yahoo shares are jumping more than four percent in early pre-market Monday trading, but lost some of those gains at the opening. So should you buy into the name now? I say no, and here are my reasons why.
First, Yahoo announced that the after-tax proceeds from the deal will be approximately $4.2 billion. Yahoo plans to return all of the cash proceeds from the deal to shareholders, and has increased its outstanding buyback by $5 billion. While a share buyback plan of that size could help put a floor under the name (Yahoo has a market cap of slightly less than $20 billion), they won't exactly be buying back $5 billion in the next month. It could take several years for them to repurchase those shares, and that doesn't solve Yahoo's biggest issue right now, it's competitiveness in the market and growth.
Just look at the following table, which compares projected revenue and earnings per share growth for Yahoo versus Google (GOOG), Microsoft (MSFT), and even Baidu (BIDU). As a side note, Microsoft's fiscal year ends in June, all others are calendar year ends.
Now, you can make the argument that the buyback will help earnings per share growth going forward. Okay, great, but that doesn't help anything at the top line.
So when you look at the valuation, Yahoo still seems a bit expensive, as I've shown in the table below. This looks at the price to earnings valuation of the four, based on currently expected earnings for this year and next for the four (fiscal year for MSFT). All price data used for this table and in following ones is as of 9:40 AM Monday morning.
Yahoo is more expensive than Google and Microsoft, and is growing much slower than them. Baidu trades for a higher premium, but it is also growing much faster. Based on this table, I would almost be tempted to short Yahoo here. But don't just take my word for it, look at what the analysts are saying. I've compiled some data on the average target for each name, with the potential upside in the name. Also included is the average analyst rating, with 1.0 being a strong buy, and 5.0 being a strong sell. Not only are analysts saying the company is a hold, but they believe it has the least upside.
So why am I saying short Yahoo? Well, it's not that I am not in favor of the deal. Yahoo needed to monetize those assets, and we had been waiting for this deal for some time. However, Yahoo just throwing the money back into its own shares won't help their main problem, and that is growth. $5 billion of shares might be bought back, but it will be over months and years. It won't happen tomorrow. Yahoo should have used the money instead to build the business. Yes, I know that they have been losing market share tremendously in recent years, but how is buying back stock going to help that? Don't forget, they just lost their CEO, after his resume was found to be wrong. This is a company whose management has not had a great track record of late, and I don't know if we can trust them going forward. While today's deal was initially positive, they are using the money in the wrong place.