Yahoo's Current Focus On Spin-Offs Is Inhibiting Value Creation

  • The Alibaba spin-off decision was an example of the problem with playing Wall Street quarterly games at the cost of long-term shareholder value creation.
  • Yahoo's spin-off efforts might be significant in unlocking hidden shareholder value but they do not address the elephant in the room that Yahoo needs to address to survive and thrive.
  • Lastly, directing management's time and resources towards spin-offs ignores Yahoo's margin compression problem. This in turn, diminishes long-term shareholder value creation.

The Alibaba spin-off idea is a testament to the company's decisions that inhibit long-term shareholder value creation for short-term happiness. Yahoo (NASDAQ:YHOO) investors should be happy with the company's decision to halt the Alibaba spin-off. Alibaba (NYSE:BABA) is currently undervalued. To maximize shareholder value, Yahoo needs to hold on to its stake in the company. On July 17th, 2015, Yahoo filed FORM N-2 in an effort to put its nearly 384 million Alibaba stocks into an independent public company called Aabaco Holdings. The deal was wrong on two main levels:

  • The $10 billion tax risk is not worth the risk. While Yahoo and its law firm were of the opinion that the spin-off would not attract any tax, there is no certainty. If Yahoo, which is taxed at the top corporate rate of 35%, is right on its tax liability, it could have saved $10 billion in taxes, but if they are wrong, $10 billion is a huge penalty for being wrong.
  • Alibaba is undervalued: For Yahoo to sell its shares in Alibaba would be short-sighted as they would be negotiating from a point  of weakness. Alibaba stock has declined mainly because of the slow down in the Chinese economy and shrinking consumer sentiments in the mainland. But Alibaba has proved the bears wrong. It beat earnings in its recent quarter and broke its own sales record on Single's Day amidst a slowing Chinese economy and declining consumer sentiments. Meaning that Alibaba is not yet trading at its full potential.

Yahoo shareholders should be happy that the spin-off did not materialize because a surge in Alibaba will act as a catalyst to Yahoo's stock appreciation in the coming months. Based on data from Thomson, with the price target summary compiled by Yahoo! Finance, Alibaba's mean target price is at $95.38/share. Representing ~14% or $11.96/share upside to the stock's current price of $83.42/share.

The acquisition premium advantage:

Yahoo's core business will raise the stock price, now that it is a potential acquisition target. Acquisition premiums represent an increased cost of buying a target company. The premium is what the acquiring company is willing to pay on top of the real value of the company. This premium becomes more plausible if there is more than one acquiring company. Therefore, in the coming year, the stock price of Yahoo will surge or decline based on the premiums acquiring companies present.

" Citi analyst Mark May writes in a new note that selling the core business is “a viable and attractive option” for Yahoo. “Not only could this outcome be a more effective way of unlocking value of its stake in Alibaba, but also the core Yahoo! business could achieve a higher value (e.g., 5-6x forward EBITDA or $3.4 – 4.1bn EV) than what is currently implied (i.e., ~2.5x forward EBITDA or $1.7bn EV) given its scale and strategic value to what we believe is likely a number of potential buyers,” he continued."

Taking the projections from Citi for $3.4 - 4.1 billion as the target projections and using the 944.36 million shares outstanding for Yahoo, the acquisition would imply $3.6/share -$4.3/share upside to Yahoo's current stock price.

"The spin-off or sale of Yahoo’s core business will take up to a year. Why? “It’s very much like the work we had to do with the forward spin,” Goldman said. That means audits, contracts, SEC filings, reviews and approvals and much more. Incidentally, while Yahoo is not officially “for sale,” it’s quite possible someone will make an offer. Would that change the time it takes to separate Yahoo’s core from its Alibaba shares? “Not really,” said Goldman. “It’s pretty much the same.” So regardless, expect a good amount of management’s time to remain tied up in the new spin-off."

Focus On Spin-Off Will Consume Managerial Resources

The major headwind with this plan is that management's time is spent on something that has nothing to do with creating long-term shareholder value. Although the idea of returning cash to shareholders sounds like a good idea now, it is not good in the long-term because Yahoo needs the cash for acquisitions and R&D. Yahoo is still in a turnaround mode and thus having management focus on short-term needs to make Wall Street happy, having less talent dedicated to Yahoo's turnaround diminishes long-term shareholder value. This creates a misalignment between what the company needs to thrive and what management wants to do to lessen pressure from shareholders.

Both the Alibaba and Yahoo's core business spin-offs do not address the elephant in the room. Yahoo's trailing twelve month results are currently disappointing with the exception of revenues which are up ~7% from FY 2014 as shown in the table below. The company needs to direct more resources and attention towards growing revenues and maximizing margins.

financials

Source: Morningstar, Yahoo! Inc. Key Ratios

The company is currently trading at ~13% above its trailing twelve month book value of $29.91/share. The company needs to seek strategies that will enhance investor perceptions towards its future prospects. Therefore, a focus on spin-offs is taking time away from management and increasing the company's costs without addressing significant problems that Yahoo needs to tackle for it to survive and to thrive.

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