- Yahoo shares have been sliding since the company uncovered a massive data breach.
- Verizon, which had agreed to purchase Yahoo's core, is likely to use this revelation to renegotiate the price lower.
- After gaining nearly 30% YTD, do Yahoo shares have any upside left?.
Yahoo Inc. (NSDQ:YHOO) shares have enjoyed a welcome reprieve this year, at one point climbing as much as 35% YTD on the back of the sale of the company's core Internet business to Verizon (NYSE:VZ). But the shares have lately been sliding, losing 6% over the past one week in the aftermath of the company disclosing a massive data breach. Yahoo has confirmed that 500M user accounts were compromised in a Russian-tied hacking incident that took place in 2014. The company says that certain copies of user account information were stolen from its network by what it suspects to be a state-sponsored actor.
And now Verizon is understandably not happy with the new development. Verizon had earlier agreed to purchase Yahoo's core for $4.8B, but Yahoo failed to inform it about the attack in time. Verizon CEO Tim Armstrong has already appeared on CNBC where he avoided answering directly to the question of how this would impact on the proposed buyout. Armstrong though hinted that Verizon might seek to renegotiate the deal by saying that the important thing is whether Yahoo was aware of the attack by the time of the negotiations. Investors should therefore not be surprised if Verizon wants to come back to the negotiating table.
Despite the unfortunate incident, Yahoo shares are still up 27.2% YTD.
Any upside for YHOO stock?
The sale of Yahoo's core Internet business is quite a complicated process. Yahoo will first have to transfer any assets that are related to the core business to a singular subsidiary. This is what will be sold to Verizon. Other Yahoo assets including the company's patents as well as stakes in Yahoo Japan and Alibaba (NYSE:BABA) will be consolidated into a single company which will be renamed.
Yahoo shareholders will not receive any cash at first unless Yahoo decides to use the proceeds of the sale to pay a dividend (after taxes). Since this is simply an asset sale and not a normal merger, existing Yahoo shareholders will not have appraisal rights and will therefore not be able to do anything about the price offer by Verizon. Existing shareholders will be left holding shares of the renamed company. This new company will become an investment company. The investment company will only hold securities for investment but not operate any business. So any value that will be left in Yahoo after the sale will be closely tied to whether the company can monetize the rest of its assets and return the cash to shareholders.
But monetizing those assets will not be a walk in the park. Alibaba recently turned down the offer to buy back the 15% stake that Yahoo owns in the company due to the possibility of facing a huge tax bill. Alibaba executive vice chairman Joseph Tsai said:
"If there was an easy tax solution someone would have figured it out already,"
Investors though remain optimistic that Alibaba will rethink its position and agree to buy the shares sooner rather than later. Alibaba has an enterprise value of $272.37B, implying that Yahoo's stake in the company would come to about $40.84B while the company's 35.5% stake in Yahoo Japan is worth about $8.1B. It's very likely that Alibaba would only agree to buy back the Yahoo stake at a discounted price, say 10%, due to the tax hit. The same case goes for Yahoo Japan. Assuming the sale of the core business will be fully taxed and that Yahoo will receive $1.5B for its patents, then Yahoo could be worth as much as $56/share or 31% upside from the current price.
Monetizing Yahoo's remaining assets will take time
It's not very likely that Yahoo shares will reflect this valuation any time soon due to the ongoing uncertainty whether Alibaba will buy back the Yahoo stake. The U.S. Internal Revenue Service has refused to provide any assurances that the transactions would be tax-free, so a company like Alibaba might end up negotiating a huge 20%+ discount for the Yahoo stake.
The bright part though is that Alibaba, which currently represents more than 70% of the value of Yahoo, has been on a tear, climbing 26.5% since the Verizon deal was announced about two months ago. BABA stock has tucked on gains of 32% YTD. Much of those gains have been driven by stellar results for the June quarter. The company reported revenue of $4.84B and EPS of $0.74, handily beating Wall Street estimates of $4.6B and $0.61. Meanwhile, Alibaba officially became a mobile-driven eCommerce player after mobile revenues more than doubled to $2.64B, or 54.4% of revenue.
Judging by Alibaba's strong momentum, it makes sense to continue holding Yahoo shares despite the looming risk that Verizon might renegotiate the sale price downwards. It might take another two years for the rest of Yahoo's assets to be sold and the company's value to be fully unlocked.