It's been fascinating to watch Yahoo evolve over the years. Started as a web directory business by Jerry Yang and David Filo in 1994, Yahoo grew rapidly in the 90s and became an Internet darling. After the tech bust, Yahoo continued launching new products and services but eventually started running into problems. They turned down a $44B acquisition offer from Microsoft in 2008, stating that Microsoft was undervaluing the company. Three years later, Yahoo had a market cap of just $22B. That's when the company started churning through CEOs to see if something could be done. Jerry Yang, Carol Bartz, Tim Morse, Scott Thompson, Ross Levinsohn and Marissa Mayer have all been at the helm at various times since 2007. Along the way in 2005, Jerry Yang acquired a strategic stake in Alibaba. He put in $1B in cash and the assets from Yahoo China, worth $700M, for a whopping 40% of Alibaba. That investment is currently worth far more than Yahoo's core business. As a result of this, public investors have had trouble valuing Yahoo in aggregate and it's been a rollercoaster ride for shareholders. Yahoo recently came up with a plan to spin-off Alibaba into a separate company. However, this would have created a very large potential tax liability, likely impacting valuation until tax issues get resolved with the IRS. Last week, Yahoo decided to suspend that plan and instead go for a reverse spin-off of their core assets, an option that they believe would maximize the value of the core business in the public markets. As always, let's take a closer look at the situation:
One look at Yahoo's share price over the past twelve months says a lot. The company has been getting pummeled by public market investors.
Yahoo's market value today is around $31B. The poor stock performance in conjunction with Alibaba's recent mega-IPO, of which Yahoo owns roughly 15%, has caused Yahoo shares to become a hot topic. Alibaba boasts a $200B market valuation and Yahoo's stake is worth over $30B (pre-tax). Yahoo Japan, of which Yahoo has a 35% stake, is worth about $8.5B (pre-tax). As it turns out, Yahoo's aggregate market value sits at about $30B in value, meaning public investors are valuing Yahoo's core business at next to nothing. They are simply valuing the asian properties and assuming some tax rate / liquidity discount. I did some quick math to show a sum-of-the-parts for Yahoo. Basically, Yahoo's share price is $32.91 today, but after you subtract out the per-share values for the Alibaba, Yahoo Japan, and Yahoo's net cash, the core business is left with a slightly negative value. I've seen various reports valuing Yahoo's core business on either side of the $0 mark depending on tax assumptions and market prices.
The above calculation shows Yahoo's core business ex-cash being worth negative $0.30. With cash, the business would be worth $4.34. Sure, Yahoo isn't exactly the hottest Internet property around these days, but should it be worth nothing? Though their growth is flat, the company still generates about $4B of annual revenue with 20%+ EBITDA margins. Applying a reasonable multiple to Yahoo's 2016 EBITDA, say 7x, yields an enterprise value of $6B . That implies a share price of over $6.00 on the core business alone, much higher than the negative $0.30 share price that I calculated above.
Yahoo's management and board of directors also believe what I stated above. So, rather than spin-off the Alibaba stake into a new company with potentially large tax liabilities, management has opted to leave the stake where it is and instead pursue a reverse-spin of Yahoo's core business and Yahoo Japan. In a reverse-spin, Yahoo's assets and liabilities, ex-Alibaba stake, would be transferred to a new company with stock distributed pro rata to Yahoo shareholders. This should theoretically remove the tax overhang plaguing the company and allow Yahoo's core business to fetch a fairer value in the public markets. While this is a shareholder friendly decision, the scenario will still take a year or more to complete and a lot can happen in that time. It's also a very complex transaction and Yahoo will have to deal with things like renegotiation of many 3rd party partner contracts and operating agreements, get shareholder approval, and deal with a host of SEC-related items. There is also some additional upside to the shares in the event that 1) Yahoo's core business gets acquired, 2) their Asian assets appreciate, or 3) they manage to turnaround their flailing core business.
Yahoo's Core Business
Years ago, Yahoo's core business could have fetched tens of billions in an acquisition. After all, Microsoft once offered to buy it for $44B before Alibaba even became a factor. Frankly, the business hasn't changed all that much since then. In 2008, Yahoo did $7.2B of revenue with 18% EBITDA, and in 2015 the business will do $4B of revenue with 23% EBITDA. An acquirer would be able to buy:
- Yahoo's search business - still generates $400M in quarterly revenue, though Yahoo handed off much of their search technology to Microsoft when they partnered in 2010
- Yahoo websites - includes the homepage, Yahoo Finance, Yahoo Mail, and Yahoo Fantasy sports. Yahoo's online properties draw more than a billion users every month including over 600 million mobile users
- Tumblr - Social blogging company Yahoo bought for $1.1B in 2013
- Flurry - Mobile analytics company that Yahoo bought in 2014 for $270M
- A number of other small apps and services, either home grown or acquired over the years
- A strong balance sheet consisting of $5.9B of cash and $1.6B in property and equipment
Unfortunately for Yahoo, their core business appears to public investors as nothing more than a holding company for more interesting assets such as Alibaba and Yahoo Japan. This is a shame since Yahoo's core business is still surprisingly large and has potential. With $6B of cash on the balance sheet (and potentially more cash from their asian holdings if they could get liquidity), it would be exciting to see Yahoo make some bold moves. Theoretically, if Yahoo sold some of their BABA stake and had, say, $20B of total cash on their balance sheet, they could buy some amazing assets. Last I checked, there were about 100 "unicorns" alone worth around $1B that could be purchased by a cash-rich Yahoo.
Financials, organizational structure, and valuations are usually a lot simpler in the private markets. It's been interesting to watch Marissa Mayer and her board of directors explore strategic options to turn around the company. Unfortunately, they are required to think about the business from the perspective of fiduciary custodians, which leads to conservative decision-making focused on short-term shareholder value, not the type of long-term value mindset exemplified by industry leaders such as Facebook, Amazon and Apple.