- Aabaco is CEO Mayer’s biggest test since she stepped into office.
- Yahoo clears the way for a tax-free spin-off.
- Sophisticated investors could use this event for nice gains.
After years of anticipation, Yahoo (NASDAQ:YHOO) is finally spinning off its huge Alibaba (NYSE:BABA) stake into a newly-formed company named Aabaco. Yahoo initially announced the Aabaco spin-off back in July when it filed an N2 document with the SEC describing the spin-off mechanism, Aabaco's business focus, and taxation elements. For Yahoo’s CEO, Marissa Mayer, the Aabaco spin-off is the most important move she has made since stepping into office in 2012, after she succeeded to revive Yahoo and return it to the frontline of internet companies. Yahoo holds significant equity stake in Alibaba, Yahoo Japan, and Hortonworks (NASDAQ:HDP), and as the value of its investments has grown over the last few years, its core business value has declined and Yahoo was at risk of being categorized as an investment firm, which would have required the company to make many changes to its operations.
Yahoo spin-off of its Alibaba stake will enable Yahoo to cash in on its enormous $30B investment in the Chinese giant and remove the risk of being categorized as an investment firm. From Yahoo’s stockholders' point of view, much of Yahoo’s value was in their Alibaba’s equities; therefore, splitting Yahoo’s share in Alibaba will allow Yahoo’s stockholders to separate their Yahoo value from their Alibaba value. However, spinning-off an equity stake into a newly formed public company is more complicated than a simple spin-off. In order for this move to be categorized as a tax-free spin-off, Yahoo needed to move some of its operations to the new company. Yahoo’s small business services unit was chosen, and it will become a division within Aabaco.
Even though Aabaco will contain a tech operating division, its main goal and business is to hold, invest, and trade in Alibaba’s shares, which were worth more than 95% of Aabaco’s assets on the balance sheet. De facto Yahoo will create a special purpose enterprise (‘SPE’) whose sole purpose will be to invest in Alibaba shares. As the majority of the new SPE will evolve around investing in Alibaba, concerns were raised that yahoo spin-off will not meet the IRS's strict requirements for a tax-free spin-off. To clear these concerns, Yahoo asked the IRS for a preliminary ruling that notes that the Aabaco spin-off meets the tax-free requirements.
Concerns about the tax-free status of the spin-off grew even larger when the IRS refused to provide any pre-ruling in this matter. However, an IRS official commented on this decision, saying: “IRS decision isn't a description of future guidance, and that nothing in [the] notice affects an immediate retroactive date." This comment placated investors a bit, as it means that the IRS' refusal to provide pre-ruling doesn’t mean it meets or doesn’t meet the tax-free requirements.
As I mentioned above, this is CEO Mayer's biggest move (and test) so far, and she cannot afford not to complete this transaction for the stockholders’ and the company’s benefit. To resolve this, Yahoo announced that the company would proceed with the spin-off anyway and publish a tax opinion from leading Wall Street law firm Skadden, Arps, Slate, Meagher & Flom concluding whether or not the spin-off would qualify for the tax-free requirements and whether or not the IRS could defend a different decision in court.
Common retail investors will probably want to stay away from this spin-off; however, more sophisticated investors could benefit from Yahoo’s stock price appreciation until the spin-off (potential investors will buy Yahoo now to get Aabaco shares later), the merger arbitrage between Yahoo and Aabaco shortly after the spin-off, and an arbitrage trading between Aabaco shares to Alibaba’s shares. A specific analysis of possible gains will be published once the spin-off dates and prices are released.