In this article I will simply attempt to calculate the value of Yahoo (YHOO) shares to owners based on three possible scenarios which may occur:
- Yahoo spins off Alibaba (NYSE:BABA) stake as a separate public company.
- Alibaba or a Private Equity firm purchases Yahoo.
- Yahoo sells the Alibaba stake on the open market and pays 38% of gains in tax.
Assumptions I make in all calculations:
- Alibaba trades at $90 per share
- Yahoo's property and patents are worth zero. (They are not, but they are hard to value.)
Value of Core Business
The simplest way to value Yahoo's operations is to compare it with the only other large white elephant of the Internet - AOL (NYSE:AOL). Currently, AOL trades at 8.0x EBITDA. However, it would be unfair to apply the same multiple as AOL's revenues have slightly grown in the past three years while Yahoo's revenues have actually declined.
Yahoo's earnings have also declined 8% in FY 2013 compared to 2013 as demonstrated by the $134,482,000 decline in adjusted EBITDA in the table below.
Above table taken from 2013 10-K.
Therefore, I believe applying a 15% discount to the EBITDA multiple is justified. After applying a 6.8x EBITDA multiple to Yahoo's FY 2013 numbers, we get a value of $10.6 billion.
Scenario 1: Yahoo spins off Alibaba stake as a separate public company.
Possibility: Very Likely
The process of spinning off the stake is very simple. Yahoo has to wait for the 1 year lock up period to expire. Then, they give every Yahoo shareholder a Y number of Alibaba shares placed inside a holding company. The holding company will trade at a discount to Alibaba shares (possibly 5-10%) until Alibaba decides to purchase the holding entity.
This is the most tax efficient way for Yahoo to dispose of its Alibaba stake. It is a practice which has been used in the past and pretty recently by Liberty Interactive Corp. (LINTA) to spin off its TripAdvisor stake.
Value of Yahoo Inc.
If Yahoo spins off the entire 16.3% stake in Alibaba, Yahoo is worth at least $62.8 per share which is 57% above the current share price hovering around $39.
However, do not expect Yahoo to spin off its entire 16.3% stake to shareholders. Except management to sell a portion of the Alibaba shares, pay the ridiculous tax and waste the proceeds on an unprofitable acquisition.
Scenario 2: Alibaba purchases Yahoo.
Before Alibaba purchases Yahoo, it has to find someone else to purchase Yahoo's core operations. Its bid to purchase Yahoo also has to be accepted by the board. Alibaba would probably sell off the Yahoo Japan stake and pay taxes of 20% in Japan.
The 35% stake in Yahoo Japan is currently listed on the balance sheet at $2.44 billion. It would be difficult to unload the stake in the stock market because the public float of Yahoo Japan is only 36% of all shares outstanding. Let's assume that Alibaba floats the Yahoo Japan shares at a 10% discount, Alibaba receives 7.62B which is a profit of 5.18B. Then, the Japanese tax bill for Alibaba comes to 1.04B. Therefore, the Yahoo Japan stake might only be worth 6.58B to Alibaba or $1.9B less than market value.
However, the proceeds from the Alibaba IPO are worth more to Alibaba than it is to Yahoo shareholders. The proceeds from the IPO are currently sitting in a Hong Kong holding company. In the previous calculations, I assumed that the cash generated from selling Alibaba shares in the IPO will be brought to the US. If Alibaba purchases Yahoo, it does not need to bring the cash to the US and does not pay income tax. Therefore, proceeds from the IPO jump by $2B to $7B. Even though the Yahoo Japan stake is worth$1.9B less to Alibaba, the $2B gain on Hong Kong cash cancels out the effects of the sale of Yahoo Japan.
Value of Yahoo Inc.
Let's consider this for a moment:
- The current market value of Yahoo is hovering around $39B.
- The value of Yahoo to Alibaba including Yahoo operations is currently at $62.5B.
- The value of Yahoo to Alibaba excluding Yahoo operations is currently at $51.9B.
- Alibaba could pay $52 per share for Yahoo, a premium of 33% above the current share price of $39 and get Yahoo's core operations for free.
Even though many would consider a 33% premium fair for a company with declining revenues and income, Yahoo's board will never accept such an offer. Accepting such a price would mean they were essentially managing an asset worth $0, which is something their ego will not allow even though it is a very profitable outcome for shareholders. Thus Alibaba would have to bid above $52 to get their bid even considered. A bid for Yahoo between $60-70 per share would value core operations between $8-18B and increase the premium to 54-79%.
Scenario 3: Yahoo sells the Alibaba stake on the open market and pays 38% of gains in tax. (The Nightmare)
Possibility: Very Unlikely.
The 16.3% stake in Alibaba is currently valued at $1.07B on Yahoo's books. Assuming the shares are sold at $90, Yahoo will receive $22.5B after taxes.
If we assume that the Yahoo Japan stake is also sold, the value of Yahoo excluding operations is $36.2B. The value of Yahoo including operations is $46.8B or $47 per share which is 21% above current prices.
Value of Yahoo Inc.
In such a situation, I doubt management would return all of the cash to shareholders. So, it would be prudent to assume that Yahoo makes a $7.5B acquisition, initiates a 2% dividend and announces a $15B buyback. The value of Yahoo would then drop to $39.3B or $39.5 per share which is the price that Yahoo stock is currently trading around.
In this article, I did not consider the likelihood of Softbank (OTCPK:SFTBF) purchasing Yahoo and holding onto both the Alibaba and Yahoo Japan stakes because it is an extremely unlikely scenario. Softbank would have to sell one of its major assets such as Sprint to pay $55-75B for Yahoo.
The market is not severely undervaluing Yahoo. It simply expects that the mismanagement which led Yahoo shares to fall from $43 on Dec. 2005 to $16 on Dec. 2011 (a 63% decline) will be repeated yet again.
However, I do doubt that any activist will allow Yahoo to potentially destroy $15B in shareholder value. Considering that a significantly negative scenario has been priced in, I would HOLD Yahoo shares until:
- An activist investor accumulates a 5% stake and files a 13D.
- The lock up on Yahoo's Alibaba stake expires.
- Yahoo announces plans for the 16.3% Alibaba stake.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.