Why I'm Still Holding Yahoo Stock

| About: Altaba, Inc. (AABA)
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Mayer addresses Jackson presentations and allegations about corporate spending.

The current preferred path to get rid of the Alibaba shares is a reverse spin-off.

Global footprint reduced and operating expenses reduced.

There were quite a few things said on the Yahoo (YHOO) earnings call that I liked a lot. To sum it up:

  • Mayer addressing rumors about frivolous spending
  • Clearly laying out the current idea of how to get rid of the Alibaba (NYSE:BABA) shares.
  • An operating expense reduction.

The frivolous spending

It surprised me that Mayer addressed this issue head on, but she did. The rumors in the media were incited by a presentation sent to the Yahoo board by Eric Jackson of Springowl Asset Management. Some of the arguments were quite personal so I can understand Mayer didn't like it very much. It's a 99-slide presentation and she didn't address every issue, but was quite transparent on the ones she did address (emphasis added):

On the issue of costs, I want to take a moment to discuss some blatant falsehoods that have been circulating in the press about the company's spending. I have found these untruths to be upsetting, and I'm sure our investors have as well. And while we do not have time on today's call to address all the inaccurate information, I want to touch on a few. For example, there have been reports of a $7 million holiday party and a $450 million spend on food over the past few years at the company. Both numbers are exaggerated by more than a factor of three. Our holiday parties globally cost approximately $150 per invited attendee. Our food program is extremely well run and all of our employee perks are standard for our industry, in line with other companies in our area and generally run less expensively here than elsewhere.

There has been a discussion of millions of dollars spent on free smartphones. The notion of free implies that these were given to employees. These phones remain property of the company, much like the desks, chairs and computers we issue to employees. Further, as is obvious from this call, mobile is a huge part of our strategy. We could not have built a billion-dollar mobile advertising business, one of the largest in the world, if the people building it did not use the tools, platforms and products we expect our users to use. There are many more examples of untruths and mischaracterizations. We can't touch on all of them. However, please know that we are very thoughtful about how we spend company resources, and we will continue to be.

As long as Jackson made his best effort to estimate what the company spent (a little bit of exaggeration is expected as he tries to make a point), I applaud him. At the same time, I like how Mayer addressed it openly and is taking the accusation seriously. I hope not too much time and money is spent on fighting Jackson about things that are untrue anyway. Some tension between shareholders (who have the right to the residual value of the company) and other stakeholders, such as employees who want to work at a great place, is natural and healthy.

The Alibaba shares

You can't talk about Yahoo without talking about the Alibaba shares (15% stake worth ~$26 billion). Although, it has turned out to have been an excellent investment, the stake is becoming a huge drag on the company. It is very hard for Yahoo to incentivize its personnel by giving them stock options. No matter how many they hold, how they do is more determined by Jack Ma's latest whim than their daily efforts. Being a tech company with an ineffectual stock option plan is bad. Remember, over a year ago how much people lamented about Google's (NASDAQ:GOOG) (NASDAQ:GOOGL) stock that didn't move and how talent was fleeing because of it. Well, this is much worse.

Because of the Alibaba stake, it is also very hard to buy Yahoo. You need a much bigger bag of money than the core operations are worth. The current plan is to do a reverse spin where Yahoo core and Yahoo Japan (another equity holding) are spun off from the company holding the Alibaba equity holding. Mayer does mention other strategic alternatives are considered, as we should expect, but this is now clearly the focus. This also puts the company's management and board on the same page as Starboard Value, the activist fund, that has been agitating about a reversal of course because the previous strategic path was deemed too risky. The main risk with this transaction is that Yahoo will have to bear long-term capital gains tax which would be very value destructive compared to alternatives:

Per our announcements in December, we have been focused on and evaluating a reverse spin transaction, whereby Yahoo!'s operating business and equity holdings in Yahoo! Japan will be separated into a new operating entity. In addition to continuing the work on the reverse spin, the board will also engage with other qualified strategic proposals. Both the board and management feel pursuing these strategic alternatives in parallel is complementary to executing the plan. We are dedicated to being good stewards of capital and delivering shareholder value.

Operating expense reduction

It is a brave step by a CEO to see the need to cut back global footprint. No CEO likes to do it. Yahoo is now closing five global offices: Dubai, Mexico City, Buenos Aires, Madrid and Milan. These are all offices in metropolitan areas, which tend to be expensive to maintain. It is very sad people will be losing jobs as the company also reduces the workforce by 15%, but I do not think Mayer would go down this road if the company could outearn its cost of capital by keeping everyone on. I think the OpEx savings will help Yahoo post-spin and positively influence its chance of survival as a standalone company.

With a market cap of nearly $28 billion, Yahoo remains incredibly cheap. It has over $4 billion of net cash, $26 billion of Alibaba shares and $7 billion of Yahoo Japan shares. Just these assets add up to $37 billion. Even after tax, these assets alone outstrip Yahoo's current market cap. We would almost forget Yahoo is actually on ongoing business as well. One which Mayer aims to get to $1 billion in EBITDA by the second half of 2016. She may not reach that number, although $400 in OpEx reductions should go a long way, but even if she comes anywhere close that means there is tremendous value in Yahoo core. Yahoo is hardly a capital intensive business with a ton of depreciation or amortization and it has very little debt, so few interest expenses. Remember the value estimates of Tumblr pre-acquisition. Sure some of it was written off but is not suddenly worth nothing? I don't think so, Yahoo core isn't the most exciting tech business ever, but it isn't worthless. I'm happily sitting this one out, waiting for a transaction (or several) to unlock the value present here.

Disclosure: I am/we are long YHOO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.