It has been a busy few days for Yahoo! Inc. (YHOO). First, on July 16, the company announced the hiring of a permanent CEO, and it was not Ross Levinsohn. Instead, Yahoo announced that Marissa Mayer will become the CEO. This surprised the market, which clearly thought that Ross Levinsohn would get the nod. The market thought this because no one thought someone of Ms. Mayer's stature and Google pedigree would take the Yahoo job (more on this point shortly). The fact that Ms. Mayer is pregnant is irrelevant. While the press may use this as an excuse to debate the difficulties of working women, true investors will not be distracted.
Second, on July 17, one day after the CEO announcement, Yahoo announced second-quarter earnings. This is where it gets interesting. Yahoo announced flat revenue and adjusted earnings of $0.27, a 47% increase over last year. EBITDA adjusted for restructuring and other one-time charges increased a little over 4%. What's interesting about these earnings and what makes this quarter the turning point for Yahoo is not obvious in the numbers. It is not the EPS growth, which was largely driven by the non-cash contribution of Yahoo's equity interest in Alibaba Group.
What is impressive is the fact that revenue held steady. A year ago, Carol Bartz was Yahoo's CEO, the company had a terrible relationship with Alibaba Group whose founder Jack Ma had pulled Alipay out of the Group without consulting Yahoo, and Yahoo's sales force was in disarray and being blamed for poor results. Since then, Carol Bartz has been fired, co-founder Jerry Yang has left the company, Scott Thompson has been hired and fired as the result of an inflated resume, an activist investor has dismantled and reconstructed the board, and now Marissa Mayer has been hired. Over this period of turmoil, Yahoo has lost talent, as Google, Facebook, LinkedIn, Twitter, etc., have been seen as far more attractive tech opportunities.
Why is now the turning point as opposed to yet another squandered opportunity? First, the hiring of Ms. Mayer has been made by a new board that includes Yahoo's largest independent investor who does not suffer fools and puts shareholder interests first.
Second, throughout the turmoil, Yahoo has maintained its revenue base and free cash flow. This is a company with $2.4 billion in cash on its balance sheet. Yahoo can afford to return all of the proceeds (~$4 billion) from the sale of part of its Alibaba stake to shareholders and still have plenty of dry powder for Ms. Mayer to use to execute her to-be-determined strategy.
Third, and most important, Ms. Mayer comes from Google and is highly respected in the tech world. While some commentary has suggested that she has never been a CEO and her leadership qualities at the top level need to be proven, going from Google's 20th employee to a senior VP in charge of Local, Maps, and Location Services is all the proof required.
Ms. Mayer's engineering background is strong. She is clearly intelligent and motivated. But, most importantly, her willingness to take the job makes the job itself more prestigious and creates an excitement around Yahoo that hasn't existed in over a decade. Marissa Mayer has a Silicon Valley aura based on her success at Google. This aura is being transferred to Yahoo and it will help attract and retain talent. This may be the single most important reason that Yahoo is now at its turning point.
The sum-of-the-parts valuation of Yahoo is well documented. Between the value of Yahoo's stakes in Alibaba Group and Yahoo! Japan and the cash on Yahoo's balance sheet, the market is placing little to no value on the core business.
Yahoo's 35% stake in Yahoo! Japan is worth $6.7 billion ($5.50 per share) pre-tax ($4.00 per share after-tax). Based on its agreement with Alibaba Group, Yahoo's floor valuation of its 40% stake in Alibaba is $14 billion or $11.50 per share. With $1.80 per share of net cash, Yahoo is worth $17.30, ~11% above its latest closing price before calculating the value of the core business. Yahoo's core business should be created at 6-7x EBITDA. With $1.6 billion in LTM EBITDA; this suggests a value of the core business of $8-$9 per share, putting the total value of Yahoo at mid-$20s per share.
With a stable revenue base on which to build and the energy and excitement that a true Silicon Valley leader can bring to the table, Yahoo's core business has real value. Plugging this value in the sum-of-the-parts valuation reveals that Yahoo is trading significantly below its intrinsic value.