February 4, 2016
FOR IMMEDIATE RELEASE
Brian Nelson, CFA
Phone +1 (708) 653-7546
VALUENTUM ISSUES OPEN LETTER TO MARISSA MAYER, CHIEF EXECUTIVE OFFICER OF YAHOO!
Visit Valuentum at www.valuentum.com.
Brian M. Nelson, CFA
President, Investment Research and Analysis
February 4, 2016
I think it is important for those reading this letter to know that on July 2012 you were appointed the CEO of Yahoo! (YHOO), and since then, shares of Yahoo! have expanded from ~$16 to ~$28, a capital gain of 75%. It has not been easy. Navigating the monetization of non-core assets has been nothing short of challenging in the face of shareholder pressure and media unrest. We applaud the cautious nature you and the board pursued in not rushing a traditional spin off of Alibaba shares, tax consequences unknown.
I'd like to share with you our thoughts on how to make Yahoo! the best it can be. Yahoo! can be a competitively-advantaged company that generates copious amounts of free cash flow, eventually debt-free, while catapulting the company to prominence in forward-leaning areas of mobile and e-commerce. The four-point plan outlined below will double Yahoo's intrinsic value in 10 years, by our estimates, while potentially monetizing its Alibaba (NYSE:BABA) holdings in a tax-efficient manner, pending evaluation of your tax lawyers and IRS approval.
We offer this to you simply for idea generation, not as advice:
1) What we propose is to halt immediately any plans for a spin off, a reverse spin off, or private sale of Yahoo's core assets, and instead evaluate the idea of issuing new Class B shares of Yahoo!, eventually for each share of Alibaba owned. Yahoo! would receive tax-free proceeds on the sale of the new Class B stock less banking fees. Class B shares may not be publicly-traded to avoid public-private market dislocation from Alibaba shares or Class B shares could be publicly-traded, depending on board preference.
2) In the event that 20%, for example, of Yahoo's newly-issued Class B shares are successfully placed at ~$60 each (a slight discount to Alibaba's market price), gross proceeds of ~$4.6 billion could be had, in such a hypothetical case. Approximately 77 million Class B shares would be placed (20% of Yahoo's Alibaba stake), and Yahoo! would hold in Treasury the remaining 307.2 million Class B shares, issuing them opportunistically over time. We believe that 20% of Yahoo's 15% stake in Alibaba could be placed in a manner of Class B shares in the market soon without being disruptive. We do not believe raising new equity is a taxable event, as it neither is a distribution of Alibaba shares or a spinoff of them. It is our belief that Class B shares could also be structured in any number of ways to avoid any transfer of ownership of Alibaba, a potential tax event.
3) Even if steps 1 and 2 prove not feasible to facilitate tax-free monetization under US tax code, we believe Yahoo! should not break itself up but strive to acquire the following instead: undervalued assets that generate a tremendous amount of free cash flow that would also benefit from its high-traffic properties, namely Tumblr and Flickr. In particular, we believe Yahoo! should take steps to acquire a company that is targeting net revenue in the range $8.5-$8.8 billion in 2016, growing at a pace of 2%-5%, excluding foreign exchange. This company consistently generates more than $2 billion in traditional free cash flow generation, cash flow from operations less all capital spending ($2.25 billion in 2013, $2.6 billion in 2014, and $2.2 billion in 2015). Free cash flow for this company is targeted at $2.2-$2.4 billion in 2016. This company is eBay (NASDAQ:EBAY).
4) Yahoo! could use the proceeds of Class B shares and/or finance the balance with the ~$5.9 billion of cash on hand and incremental debt issuance. There are few other complimentary businesses, in our view, that offer traditional free cash flow yields of ~10% and have negligible net debt, and we believe now-standalone eBay would consider the opportunity to further embed its presence in some of the most widely-visited areas on the web. From where we stand, a combination would create an e-commerce giant that could leverage Yahoo's core properties, thereby accelerating legacy eBay's organic growth and enhance its competitive position against Amazon (NASDAQ:AMZN), while Yahoo! would strengthen its core as it develops "thought areas" along the lines of Google's (NASDAQ:GOOG) "other bets." We'd be speculating over deal terms, but it's logical that a payback period based on eBay's expected traditional free cash flow generation alone, excluding synergies, would be less than a decade. On the basis of the combined entity's would-be free cash flow generation and eBay's post-PayPal (NASDAQ:PYPL) spin-off credit rating of BBB+ by Standard & Poor's, we would expect any new debt raised by Yahoo! in this transaction to be rated investment grade. Assuming a very conservative discount rate of 10%, we would value every $100 million in Yahoo-eBay cost synergies as $1 billion in incremental deal value generated.
We offer these four steps in the spirit of idea generation. We believe they will augment Yahoo's intrinsic value, position it favorably from a competitive standpoint, enhance its existing properties, while facilitating a growth engine for innovation. We believe the creation of Class B shares could effectively "monetize" Yahoo's Alibaba stake, priced by the market at ~$23 billion, while stimulating innovation within Yahoo's core properties, as it folds in an undervalued eBay and generates synergies along the way. By 2025, we believe Yahoo! would garner an intrinsic equity value of more than $55 billion, debt free, assuming no incremental growth from today, just from the financing transactions and debt retirement. A doubling of equity value over a 10-year period implies an 8%+ compound annual growth rate in equity value, a base case return assuming no synergies or successes in the innovation pipeline stimulated by combining two very talented Yahoo and eBay teams.
Valuentum is neither an asset manager, nor a financial advisor, nor an investment banker, nor a broker, nor a tax lawyer, nor an accountant. In any case, we wanted to share some of our thoughts, and we trust you may find many of these insights helpful, if not worthy of consideration. We believe each of the steps should be evaluated for feasibility in light of the desired outcome, as no guarantees can be made.
Brian Nelson, CFA
President, Investment Research
Disclosure: Brian Nelson and Valuentum do not own shares in any companies mentioned in this letter.
Disclaimer: Valuentum is not a registered investment advisor and does not offer brokerage or investment banking services and adheres to professional standards and abides by formal codes of ethics that put the interests of clients and subscribers ahead of their own. This letter is for information purposes only and should not be considered a solicitation to buy or sell any security, or engage in any transaction. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this letter and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the letter and are subject to change without notice. The information contained within does not constitute advice, especially on the tax consequences or legal implications of making any particular decision or performing any transaction. The material is not intended for any specific type of investor and does not take into account an investor's particular investment objectives, financial situation or needs. Readers should consider their particular circumstances, those of their firm, perform their own due-diligence, and if necessary, seek professional advice. This letter is for idea generation only.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: PYPL and GOOG are included in Valuentum's Best Ideas Newsletter portfolio.