Yahoo! (YHOO) has been beaten down over the years by Wall Street and other institutional investors who have written off the company as a "has been" internet search company. Indeed, one reason I invested in Google (GOOG) in the past is because they were so far ahead of Yahoo! in internet search. It is true that Yahoo missed many of the trends over the past decade: social, mobile, local, etc. However, I find value in Yahoo's stock right now, and internet search is only a small factor constituting that value.
Yahoo owns a 40% stake in a leading Chinese internet company that is currently overlooked and undervalued by the market: Alibaba Group. Alibaba is a very successful company in China that has a stranglehold on many important markets in e-commerce today. To make a comparison, if Amazon (AMZN), eBay (EBAY), and Staples (SPLS) all merged together, the newly formed entity would look a lot like an American version of Alibaba. Here is a quote taken from Daniel Loeb's Fourth Quarter 2011 Investor Letter. His fund, Third Point LLC, owns a large stake in Yahoo!:
According to iResearch, Alibaba currently has 49% of the B2B e‐commerce market (four times greater than its nearest competitor), 90% of the C2C e‐commerce market (analogous to Ebay), and 53% of the B2C e‐commerce market (analogous to Amazon) in 2011. It has complemented these core commerce positions with the leading online payment platform, Alipay, with 49% market share, and also holds the #2 share of the Chinese online ad market (17%, behind Baidu at 28%). Particularly exciting is Alibaba's share of China's rapidly growing B2C market represented by Taobao Mall, or Tmall (recently renamed Tian Mao).
Alibaba is a wonderful company that many investors would rightly love to own directly, but alas, it is not publicly traded. But don't despair. By owning Yahoo!, you can vicariously own 40% of this dominant company.
If you've ever kicked yourself for not investing in eBay or Amazon during those early years, now's your chance to go back in time and correct those mistakes. Alibaba is a tech company a lot like those two companies that literally monopolize several of the fastest growing industries in the world, and they are located in a country that will experience exponential population growth along with rapid growth in technology and infrastructure as it catches up with America and the rest of the West. And best yet, their business models have already been proven to work, just like eBay and Amazon.
Here's another quote from Loeb from the same letter:
The scale and velocity of China's e‐commerce opportunity, when combined with Alibaba's dominant position, make for a very compelling story. As it moves toward an IPO, Alibaba should quickly take its place amongst China's online leaders - Tencent ($47 billion market cap), and Baidu ($48 billion market cap). A November 2011 report on Softbank by UBS's Makio Inui, the product of extensive research into Alibaba Group and a detailed valuation, placed a $63 billion value on Alibaba Group, which would imply just over $13 per Yahoo share after tax. It appears that while 2012 will be the year of Facebook, 2013 could very well be the year of Alibaba as it moves toward a listing.
That $13 number has moved higher since he wrote that, since YHOO has recently bought back shares. As I see it, if the $63 billion value is correct, Yahoo's 40% stake is equal to $21.36 per YHOO share, which is already much higher than the $14.65 that YHOO as a whole trades at right now, and Alibaba is only a piece of the Yahoo pie. If we conservatively ratchet down the value of Alibaba to more like $40 billion, Yahoo's stake is worth $13.40 per share.
Two More Pieces: Yahoo! Japan and Net Cash
Yahoo's investment in Yahoo Japan (OTCPK:YAHOY) is more easily calculated, since Yahoo Japan trades publicly. According to their most recent 10-Q, YHOO's 35% stake in Yahoo Japan was worth about $6.5 billion. However, in the 2 months since that filing, Yahoo Japan's stock price has appreciated about 6%. Going through the math, that would make Yahoo's stake in Yahoo Japan worth about $3.46 per share.
From their most recent 10-Q:
|June 30, 2012||August 31,2012|
|Japan stake pre-tax||$6,500,000,000||$6,886,258,124|
|YAHOY's market cap||$18,571,428,571||$19,675,023,213|
|Japan stake post-tax||$3,900,000,000||$4,131,754,875|
|Per share value||$3.27||$3.46|
YHOO's net cash per share is $1.60 (including short-term debt and government securities). If we add all these up and compare it to today's stock price, it would give an implied value to Yahoo's core business in online search advertising (yes, we haven't even talked about that yet) of negative $3.81! Obviously this is not the case. Yahoo's core business may leave a lot to be desired, but it's a solid, reliable cash cow that brings in hundreds of millions in free cash flow per year, give or take.
The Last Piece: Yahoo's Core Business
Looking at YHOO's 10-K filings down through the years reveals how much the company has recorded in earnings from equity interests (using the Equity Method) from Alibaba and Yahoo Japan. Below is a table with those two components carved out in order to present Yahoo's core business earnings, as a standalone number without the help of its two greatest investments.
|less Alibaba's contribution||(30)||(30)||(273)||25||(42)||(90)|
|less Yahoo Japan's contribution||(128)||(147)||(153)||(212)||(300)||(400)||(400)|
|Yahoo's Core Business Earnings||1,768||1,719||477||(61)||323||790||559|
|Core business earnings as % of Total||93.2%||90.7%||72.3%||(14.4%)||54%||64.1%||53.3%|
As you can see, Yahoo's core business earnings as a percentage of total earnings have been decreasing over the years as Alibaba and Yahoo Japan continue to increase in value and make up more and more of Yahoo's earnings. However, we can't just discount this area totally, like the market is doing right now. A reasonable estimate may be to take the average of the last three years of results and expect Yahoo's core business to contribute near that amount in the future. If we can count on new CEO Marissa Mayer to grow these earnings a mere 3% per year for 10 years, that's a net present value of $3.04 per share (using a discount rate of 12%). Or perhaps we could assign a multiple to the core business segment. At $3.04, that translates to a mere 6.5x multiple on Yahoo's core business, which is conservative.
Adding all the pieces up, we get a valuation that looks like this:
|Yahoo Japan stake||$3.46|
|Net Cash per share||$1.60|
|Total Valuation (per share)||$21.50|
At Yahoo's present stock price of $14.65, the above valuation implies a 47% possible upside in shares of YHOO. Even if you value Yahoo's domestic search business at a big 'ole goose-egg (in other words, zero), the shares still seem undervalued at today's prices because of Yahoo's ownership of Alibaba and Yahoo Japan.
Because Alibaba and Yahoo have recently reached an agreement in which Alibaba will buy back some of Yahoo's interest in the company, possibly as early as in Q3 (which is right now), I see this as a near-term catalyst of value realization for shareholders. In addition, Marissa Mayer should be an asset to the company and should add momentum to the share price. Loeb, quoted above, has put his money where his mouth is, buying nearly $40 million of Yahoo stock last month. In total, Loeb has put over 12% of his $9 billion hedge fund into Yahoo shares.
YHOO stock could decline a little more over the coming months, but with the Alibaba deal expected in Q3, I don't really see a lot more downside from here.