Yahoo (YHOO) is an interesting buy candidate among big web players because it can liquidate significant non-core assets and because its new CEO is redefining the firm. Shares of Yahoo are more attractively priced than its well-loved competitors Facebook (FB) and Google (GOOG).
Too Much Cash
Yahoo shares have been flat this year, and investors are encouraging the company's new CEO to forego paying a dividend and instead buy back shares using sales proceeds from its roughly $3 billion stake in Alibaba. According to analysts, a buyback would be a signal that the CEO is confident in Yahoo's prospects for growth.
Yahoo already used $646 million to buy back stock following its sale of Alibaba. The board is still deciding what to do with the remaining money from the transaction. Investors might want the dividend, but those looking for a long term relationship with the company would rather see a repurchase.
A one-time buyback could signal that the CEO has the ability to bring back advertisers and users who have since moved over to other search engines and social networks. By contrast, establishing a dividend policy could be interpreted as an admission by management that it does not know how to bring the business back to life. In the tech sector dividends are often seen as a signal for a lack of vision, a scarcity of compelling investment projects, and a bribe for investors if only to keep them on board.
Analysts anticipate that a buyback could boost Yahoo stock to as high as $32 in a year. Shares have fallen to $16.09 for a total market capitalization of $19.1 billion. This is modest compared to search engines and social networks which range anywhere from $50.5 billion to a whopping $251.8 billion in market capitalization.
Changing of the Guard
The ascent of new Yahoo CEO Marissa Mayer has increased the odds for the sale of other non-core assets and the return of capital to shareholders. She has demonstrated that she is not afraid to shake things up by implementing major changes in the firm's upper management line-up.
There is a lot of new blood in Yahoo's upper management. Mayer herself was a hire from Google's inner circle. In addition, Mayer replaced the incumbent chief marketing officer with Kathy Savitt, previously an executive at American Eagle Outfitters (AEO). Mayer also decided to install Ken Goldman as Yahoo's chief financial officer. Goldman comes to Yahoo with the experience of three decades of working with technology oriented companies. Most recently, he had been brought in to make serious financial decisions like he did for the security company Fortinet (FTNT). His success with making companies more efficient and profitable has made him an ideal choice for to the Yahoo CEO and shareholders.
Considering Peer Valuations
Yahoo shares trade near $16 after sustaining a -1.7% decrease in 2012 as the market rallied. The firm's current operations do not look that cheap. Investors can buy more revenues per dollar from the S&P 500 since this index has a price-to-sales ratio of 1.29 while this stock has a much higher 3.77 ratio. Yahoo shares currently trade at a high 17.81 price-to-earnings ratio, a higher value than the 14.1 average of the S&P 500 index.
However, Yahoo's value proposition lies in its ability to sell non-core assets. Its price-to-book multiple of this stock is 1.52, cheaper than the 2.05 S&P 500 average. Investors should consider this number overstated because the price-to-book ratio fails to account for internally-developed intellectual property including patents, brands and trademarks. If the economic value of these assets were even partially recorded on the balance sheet the firm's price-to-book ratio would be lower.
By contrast, Facebook stock is too expensive at a price of roughly $20, even after its post-IPO 47% price drop. Equity in this company is rich on a price-to-sales basis since shares trade at a 10.01 multiple, much higher than the 1.29 the S&P 500 average. FB shares are trading at an indefensibly high 112.37 price-to-earnings ratio. Analysts expect that the firm's earnings growth will accelerate with five-year estimates at 27.2% per year, though this really isn't enough to justify such a high P/E ratio.
Even Google stock seems richly priced at roughly $740 per share, a price level which is tough to justify. Investors can buy more revenues per dollar from the S&P 500 since this index has a price-to-sales ratio of 1.29 while this stock has a much higher 5.64 ratio. Google shares currently trade at a high 22.06 price-to-earnings ratio, a higher value than the 14.1 average of the S&P 500 index.
Among Yahoo's peers, only AOL (AOL) offers investors a more attractive value proposition at $37 per share. AOL shares are trading at a bargain 3.46 price-to-earnings ratio, less than half the S&P 500 index average. The price-to-book multiple of this stock is 1.09, about half the 2.05 S&P 500 average. It cannot be overemphasized that this number is inflated because the price-to-book ratio fails to account for internally-developed intellectual property including patents, brands and trademarks. If the economic value of these assets were even partially recorded on the balance sheet the firm's price-to-book ratio would be much lower. In terms of safety, it's hard to conceive of AOL as a value trap when it has a rock-solid 0.03 debt-to-equity ratio.
Investors should consider buying Yahoo and AOL as value positions. AOL is the deeper value, but Yahoo's buyback (or initiation of a dividend policy) will prove to investors that the firm's new management is committed to returning capital to shareholders.