- Activist investor Starboard is now pushing Yahoo to keep its Alibaba stake intact and spin-off its beleaguered Internet business instead.
- The activist argues that there is too much uncertainty surrounding the Alibaba spin-off and whether or not the IRS will tax the transaction.
- Spinning off Yahoo's core business would result in a much lower tax bill.
- Will CEO Marissa Mayer consent to the new proposal?
For all its woes, Yahoo (NASDAQ:YHOO) remains an Internet giant with a high Alexa rank of #5, with Alphabet Inc-C (NASDAQ:GOOG) and Facebook (NASDAQ:FB) taking the top 2 slots. But this is not something you can easily tell just by looking at Yahoo’s finances. Yahoo’s top line has shrunk nearly 30% over the last 7 years. Yahoo’s EBITDA has dropped by a similar margin in just the three years Marissa Mayer has been sitting at the helm as CEO.
Yahoo’s much-hyped turnaround just does not seem to have materialized, and now the company has turned to selling its highly-prized assets to please short-term investors and unlock some shareholder value. Yahoo has been contemplating selling its 15% stake in the ‘‘Amazon of China,’’ Alibaba (NYSE:BABA) after it bowed to mounting pressure from activist investor, Starboard. Yahoo is also contemplating selling its stake in Yahoo Japan.
Back then when the idea was first floated, Yahoo investors mostly supported Starboard’s activism on Yahoo because nobody had given serious thought to the tax implications of the spinoff. But it later emerged that the IRS might want into the action, and end up sticking Yahoo with a fat tax bill. At current Alibaba share price, Yahoo would have to pay ~$9 billion to the IRS if it spun-off Alibaba.
But it appears as if Yahoo’s management will be willing to push through with the spinoff whether or not the IRS ends up taxing the deal. Yahoo authorized spinning off Alibaba in September as outlined in this 8-K report, which clarifies that the company’s decision to spinoff Alibaba will not be determined by what the IRS decides to do:
‘‘On September 23, 2015, Yahoo's Board of Directors authorized the Company to continue to pursue the plan for the Aabaco spin-off transaction as previously disclosed, except that completion of the spin-off will not be conditioned upon receipt of a favorable ruling from the IRS...
On September 28, 2015, Aabaco filed Amendment No.1 to its Registration Statement on Form N-2 which is available on the SEC's website at sec.gov using the name Aabaco Holdings, Inc.
Completion of the transaction is expected to occur in the fourth quarter of 2015, subject to the conditions described above.’’
Alibaba is by far Yahoo’s most valuable asset, and accounts for a disproportionately large part of Yahoo’s valuation. At a Yahoo stock price of about $40 per share, analysts value Alibaba at $26.15 - $42.20 using the residual income method (the income Yahoo’s core business would be left with post spin-off), and depending on how the spin-off is taxed, which suggests that Yahoo’s core business might actually carry a negative valuation. Whether that is realistic even for a shrinking business with little prospects for growth is a story for another day. Meanwhile, a Monte Carlo simulation of the range of inputs values Yahoo’s remaining business at a measly $2.31-$2.75.
What other option[s] does Yahoo have?
But spinning off Alibaba is not the only option open to Yahoo--the company can choose to spin-off its core Internet business instead. Ironically, Starboard has now changed its stance on the Alibaba spin-off and now wants Yahoo to instead spin-off its core business and leave the Alibaba stake intact. This is certainly a valid option that would be less punishing to Yahoo investors since the tax bill that Yahoo would incur would clock in at ~$1.5 billion, much less than the nearly $10 billion in an Alibaba spin-off.
Whether or not the IRS will actually tax either spin-off remains to be seen. It also remains to be seen whether Miss Mayer will relent on her decision to spin-off Alibaba and instead opt for the #2 option. This is not to say that spinning of Alibaba would be devoid of any benefits for Yahoo investors because it would. Other than the short-term implication of giving Yahoo shares considerable momentum, the bigger implication would be that Yahoo shares would be unlocked from Alibaba’s and thus allow them to trade on the company’s own fundamentals. Alibaba shares are down 25% YTD, and have played a big part in Yahoo’s own return of -35% YTD.
But all other factors held constant, it appears as if spinning off Yahoo’s core business would be the more prudent thing to do here.