Yahoo’s Future Remains In Question

  • Yahoo reported its Q2 earnings last week and refused to disclose further info about the sale process.
  • The Mozilla payment clause, Tumblr write-off, and weak core results will put pressure on the deal price.
  • Even though the sale will be closed soon, investors should be ready for a downside scenario.

EDIT: Based on the latest news Verizon has agreed to buy Yahoo's core business for $4.83 billion. The deal is likely to close by early 2017.

The fading Internet giant Yahoo (NSDQ:YHOO) reported its Q2 2016 earnings recently in what might be the last earnings conference call for Yahoo as a public and independent company as we know it. In an earlier article, I had mentioned that Yahoo is so far into the process of selling its core business that its quarterly operating performance is secondary to any development in the sale, and indeed, at the beginning of the call, Marissa Mayer quickly took that off the table by saying: “Although we have no announcement today, I want to restate our commitment to delivering shareholder value through this process…  By separating Yahoo’s operating business from our equity stake in Alibaba, there is a substantial value that we can potentially unlock. To that end, the right transaction could strategically and efficiently achieve such a separation.”

For many investors who had hoped to get some additional information about the process, timeline and maybe even possible outcome, it was a disappointing opening to the call. Estimates now range between a period of one to a number of weeks until Yahoo will complete reviewing the final round bids, negotiate terms, maybe offer the final bidder to match the highest price, and finally announce the auction results. Even though CEO Mayer tried to take the sale process of the agenda, it hovers above every piece of data provided in this release.

Looking at the Q2 results with the deal in mind, there are four items that are worth highlighting and might have a significant impact on the sale outcome: the Tumblr write-off and Mozilla break-up fee, forming Excalibur LLC and the continuing decline in the search and display businesses. Yahoo acquired the microblogging site Tumblr in 2013 for $1.1B to penetrate the social media segment in an attempt to ride the rising popularity of Facebook and its peers. Yahoo believed that such a high profile acquisition would help it to get back on track and reclaim its leading internet company position.

Back in ’13, when Marissa Mayer announced that the latter would become its biggest acquisition, she promised: “not to screw this up.” However, in reality, that wasn’t the case because Tumblr failed to gain significant market share, and Yahoo wrote off $230M last quarter to reflect the plunging value of the asset. This quarter, Yahoo continued that line and wrote off another $482M of Tumblr’s value, bringing the value of the former rising star of the social media market to almost nothing. This write-off will have a direct link to the final bid price.

Another one-time hit that will have a meaningful impact on the final bid price is the Mozilla breakup fee. In 2014, Yahoo agreed to pay Mozilla, the web browser maker, more than $375M a year to make Yahoo the default search engine on Firefox. However, that agreement includes a clause that allows Mozilla to break up the partnership if it does not accept the new owners/management of Yahoo and still keep the $375M a year coming until 2019. In the call, CEO Mayer refused to provide any additional details about the Mozilla partnership and the breakup terms; however, this topic will have a direct impact on the final bid price.

In a direct link to the upcoming deal, Yahoo introduced Excalibur LLC to the market, a standalone entity that will hold 4,000 of Yahoo’s non-strategic IPs. By carving out patents and pending applications to Excalibur, Yahoo is preparing Excalibur for sale either as a whole or in parts and simplifying the due diligence and selling process. Even though it is not yet published, some of the bids for the core assets are assumed to include some parts of the Excalibur entity. In the case that the chosen bid will not include the Excalibur assets, Yahoo could pursue a sale in a separate process.

Yahoo reported higher than expected revenue figures that beat the street’s consensus. However, the main driver for that beat was the reclassification of certain revenue streams and different counting mechanisms in the cost of acquiring new traffic. Using the old accounting methods reveals a revenue decline from $1.04B to $842M YoY. The decline in the core business, especially in the search segment, highlights not only Mayer’s failure in turning the company around but also could help potential bidders push the price down amid weaker business valuations.

Although Yahoo did not disclose much about the sale process, investors could infer with a great deal of confidence that the state of the core business could not justify a bidding price at the high end of the $3B to $5B range. The stock will continue to trade according to the estimated potential deal price and the performance of Yahoo’s Asian assets. A disappointing deal price, unfavorable agreement with Mozilla, disappointing price on Excalibur, and an IRS decision not to approve a tax-free transaction among other factors might drive Yahoo’s stock sharply lower. An investor should not overlook the possible downside when Yahoo releases the deal terms.

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