January 20, 2015
During the upcoming $YHOO earnings report, we expect Marissa Mayer to detail how the company will deal with a pressing issue. How will they maximize the value of Yahoo’s exposure to Alibaba and Yahoo Japan? Their ability to deliver a tax-efficient structure could drive the next stage of growth in share price.
VALUATION. $YHOO is comprised of a variety of components – two of which are interests in public companies. A sum of the parts analysis allows us to look at the value of the individual components to derive the overall valuation of the broader company.
- Net Cash. The simplest piece of this puzzle is valuing Yahoo’s current net cash position. This looks at total cash and marketable securities, less any outstanding debt. Per the Sept 30, 2014 financials, Yahoo has $3.9 billion in net cash. This excludes cash from the Alibaba IPO, as described below.
- Yahoo HK Holdings (Cash from Alibaba IPO). Years ago, Jerry Yang acquired a significant stake in Alibaba while CEO of Yahoo. Before its IPO last September, Yahoo held over 500,000 shares of Alibaba through its Hong Kong subsidiary. As part of the IPO, Yahoo sold 140,000 shares at $67.18 (net of fees), for gross proceeds of $9.4 billion. We can’t stop there, though. In order to repatriate that cash into the U.S. so it can be distributed to shareholders, one must apply a 38% corporate tax rate to the gain. Net proceeds from the Alibaba IPO are $5.8 billion.
- Yahoo HK Holdings (On-Going Alibaba Interest). Yahoo continues to hold 383,565 shares of Alibaba. The impact on Yahoo’s valuation is driven as much by the share price of $BABA as it is by the eventual tax implications. Let’s stick with the worst case assumption of a 38% tax rate. With Alibaba trading at roughly $100 per share, that peg’s Yahoo’s interest at $23.8 billion (or $38.4 billion before taxes). However, we must look at a range here. Since its IPO, Alibaba has traded between $85 and $120. Given that price range, the tax-affected value of Yahoo’s on-going interest in Alibaba is $20.2 – $28.5 billion.
- Yahoo Japan. Yahoo owns a 35% interest in Yahoo! Japan, or just under 2 million shares. The entity is currently trading in Tokyo at a USD price per share of $3.40. The same repatriation tax implications are in effect here. Given a 10% move in price in either direction, we estimate the tax-affected value of Yahoo’s interest in Yahoo Japan to be $3.8 – $4.6 billion.
- Yahoo’s Core Business. This leaves the last component – Yahoo’s core search and advertising business. We’ve analyzed the financials over the last five years along with a number of analyst research reports to determine a reasonable set of projections over the course of the next year. After excluding its earnings in equity interests (Alibaba and Yahoo Japan), we project Yahoo will earn approximately $0.37 through next September. Based on its comps (GOOG 25.7x PE; AOL 38.0x PE; MSFT 18.2x PE), we expect the core Yahoo business would conservatively trade at a PE multiple between 20x-30x. Our projected value of Yahoo’s core business is between $7.6 – $11.4 billion.
Assuming no tax-efficient structure is found, our fair value range for $YHOO is $41.3 – $54.3 billion ($44 – $57 per share). With Alibaba trading at $100, our fair price estimate is $50 per share.
THE IMPACT OF A TAX-EFFICIENT SOLUTION. That $50 fair value estimate assumes that Yahoo management is unable to deliver a tax-efficient solution here. The significance of their finding a solution cannot be understated.
- Taxed at 30%. If Yahoo is able to limit the taxes on its current Asian assets to the 30% level, it would increase the projected fair value range to $47-$62 per share.
- Taxed at 20%. If Yahoo is able to limit the effective tax rate to 20%, it would increase the projected fair value range to $51-$67 per share.
CONCLUSION. Given our estimate of $44 – $57 per share assuming no tax-efficient structure can be found (unlikely), there appears to be little downside and significant upside based on current pricing. In fact, if management is able to deliver tax-efficiency within its Asian assets, the upside is dramatically (25%+) higher. And this does not assume any real growth in Yahoo’s underlying core business.
BONUS: The Chart. Prior to the Alibaba IPO, investors used shares of Yahoo as a way to play the Chinese internet giant. In the immediate aftermath of the IPO, shareholders fled as they now had direct access to Alibaba. Since YHOO stabilized in mid-October, it went on a dramatic surge higher from $36 to $52. Interestingly, after hitting almost exactly the 38.2% Fibonacci retracement of that recent move, shares of Yahoo bounced. The RSI and MACD both reached oversold levels. We expect the climb to continue.