Yahoo Patent Resolution Could Spur Growth

| About: Yahoo! Inc. (YHOO)

Recent news of a peace accord between Yahoo (NASDAQ:YHOO) and Facebook (NASDAQ:FB) regarding patent disputes may be a positive catalyst for Yahoo. Whether or not these two companies have really decided to settle their differences remains in doubt. Court records confirm that neither Yahoo nor Facebook has dismissed its case.

In the wake of Yahoo's sale of one-half of its 40% stake in Alibaba Group Holding Ltd. resulting in a $7.1 billion windfall for Yahoo, I expected to see favorable market reaction to such a positive catalyst resulting in a meaningful boost in share price. That did not happen. I'm rationalizing that it is probably because none of the sale proceeds have yet to make their way into the company coffers. Today, I will examine these recent catalysts and try to determine where Yahoo is headed. Lets look at Yahoo's fundamentals first.

Yahoo is trading at about $16 per share and its market capitalization stands at around $19 billion. Trailing twelve month price to earnings is 17.96 and the price to earnings growth ratio is 1.23. Yahoo price to book is reported at 1.46. As a value investor, I would have to say these metrics are within acceptable limits. Return on equity falls short of expectations at 8.75%, but quarterly year-over-year revenue and earnings growth are positive numbers, reported at 0.6% and 28.4% respectively. This positive revenue and earnings territory is something unseen by all too many companies in these turbulent times.

Yahoo's financial strength is real. It has a fractional debt to equity ratio of 0.31, a current ratio (3.25) more than 3 times the traditional benchmark of 1, and about $2 billion in cash, cash equivalents and short term investments. That said, Yahoo is almost 7% overvalued on a discounted cash flow basis and this is before the cash tide from the Alibaba sale rushes in. Yahoo fundamentals appear strong, so what will the partnering with Facebook accomplish for Yahoo shareholders?

Let's look at the gist of the agreement. Most significant is the cross-licensing of many of Yahoo's and Facebook's key patents. The details haven't been made clear at this point, but some sources suggest that all Yahoo's patents are to be shared freely with Facebook and I assume, vice versa. Yahoo and Facebook will collaborate to enhance the manner in which advertisers promote products across both platforms. That means Facebook users can look forward to links for accessing Yahoo media's large and premium event coverage.

Conversely, Yahoo aforementioned media sites will be graced by Facebook's social integration features. This is the package that will ultimately be marketed to advertisers. This article from 'TechTake' delves into the mechanics of the collaboration in greater detail. Meanwhile, Daniel Loeb has remained strangely silent on developments. I view that as a plus for acting CEO, Ross Levinsohn. Loeb's silence in this matter is a tacit nod of approval in my opinion.

AOL (NYSE:AOL) may have felt a little sting on the news of the "peace." It's difficult to say, but the fact is, AOL has been doing okay of late, surging past the S&P 500 (NYSEARCA:SPY) by a greater margin than rivals Yahoo and Google (NASDAQ:GOOG). In fact, Google now trades below its 200 day moving average which, by the way, places the stock near its fair value of $581.

Let's see how AOL's fundamentals shape up and if there are any catalysts at work that may be lifting the stock price. AOL is trading at about $28 and a market cap around $2.5 billion. Trailing twelve month price to earnings stand at 96.56 against the backdrop of a price to earnings growth ratio of 1.90 and a price to book of 1.18. Return on equity is an abysmal 1.31%.

Quarterly year-over-year revenue and earnings growth come in at -4% and 348.9%, respectively. AOL's debt to equity and current ratios are rock solid at 4.95 and 1.82, respectively. There are two significant catalysts at play here which are driving AOL's current growth. The first is its $1 billion patent deal with Microsoft (NASDAQ:MSFT) coupled with the $400 million stock repurchase segment in progress now. I believe the rally is done. For me, a long position on AOL is not prudent. AOL's earnings, from this point on, will have to come the old-fashioned way. They have to earn it.

That brings us to Yahoo. In contrast, Yahoo share prices have remained flat compared to AOL. Why didn't the Alibaba deal and the Facebook settlement catalysts do the same for Yahoo? I believe the reasons are fairly straightforward. Gates can write AOL a check for the patent deal and still have a balance of $57 billion in the checkbook. Alibaba can't do the same for Yahoo - Alibaba has to raise the money.

As all of the above plays out, Google share prices have dipped. My take is, that like grapes, poor trading decisions come in bunches. I would recommend buying on this pullback. Google's fundamentals are quite sound and it is perhaps the most innovative tech stock on the market. Google is trading at 17.47 times twelve month trailing earnings and boasts a fractional price to earnings growth ratio of 0.76. Price to book is at the apex of the limit I regard as acceptable, posting at 3.01, just above my personal limit of 3. In short, no deal-breaker. I believe the forward looking price to earnings ratio of 11.59 is but a glimpse of this company's future.

At this time, I urge investors to consider Yahoo, avoid AOL, and pick up shares of Google.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.