Upcoming Alibaba IPO Makes Yahoo A Buy

  • Display ad pricing declined, even as ad sales increased. The net impact was a moderate decline in revenue.
  • Yahoo! continues to consolidate its ad business via Gemini (ad platform).
  • Yahoo! missed analyst consensus earnings estimates by a cent, the minor miss isn’t a big problem, but the inability to lower tax expenses on the Alibaba proceeds weakened sentiment.
  • Guidance for the next quarter wasn’t very compelling, indicating that Yahoo’s! growth initiatives are expected to become more effective in fiscal year 2015.

Yahoo Q2 2014 earnings review

Yahoo (NASDAQ:YHOO) stock declined in after hours trading as the company wasn’t able to generate year-over-year revenue growth, missed analysts’ earnings estimates, and offered weak guidance for the next quarter. Furthermore, the company also mentioned that it was going to pay taxes from the proceeds of the Alibaba sale.

Despite short-term difficulties, I think the business will return to revenue growth sometime next year. Share buybacks should drive EPS growth of 5-10% over the foreseeable future. Furthermore, assuming Yahoo continues to acquire lucrative businesses, sales may grow at a much higher rate than what has been indicated by historical data. Overall, I think Yahoo’s recent drop in price should be thought of as a buying opportunity.

Yahoo to benefit from post-IPO Alibaba valuation

Marissa Mayer over the course of the Yahoo earnings conference reported weakening revenue trends. Most of this was driven by falling ad-pricing, which is a symptom of transitioning ads to a mobile/desktop platform. Mobile ads are priced significantly lower when compared to desktop ads, however Marissa communicates that the repositioning of ads transitions the company into long-term growth, despite the weakness in short-term performance metrics.

Yahoo Global display ads trend

Source: Yahoo

Furthermore, another key point that was mentioned during the earnings conference was the Alibaba sale at IPO. The number of shares required to be sold has been reduced from 208 million to 140 million.

According to Ken Goldman, CFO of Yahoo:

Today I am pleased to announce we have reduced the maximum number of shares to be sold in the Alibaba IPO to 140 million from the previous 208 million. We are aware that there has been much discussion around the allocation of the Alibaba proceeds during the IPO. On this initial tranche, we expect the proceeds to be fully taxed. And we are committed to returning at least half of the after-tax IPO proceeds to shareholders.

Yahoo currently owns 523.6 million shares, so selling 140 million shares will allow Yahoo to retain 383.6 million shares. I estimate that at a $150 billion IPO, Alibaba’s stock price will be $68.75. That translates into $9.625 billion in sales proceeds for Yahoo. After factoring in a 35% tax rate, Yahoo will be able to retain $6.25 billion. Of that amount, approximately half will go back to shareholders in the form of buybacks, which indicates that Yahoo will spend an additional $3.125 billion on share buybacks, and $3.125 billion on strategic acquisitions.

The remaining 383.6 million shares will be held onto, for capital gains purposes. It’s likely that following the Alibaba IPO, Alibaba will continue to grow its sales and earnings, which should drive Alibaba valuations higher. Alibaba is the most promising opportunity for getting a piece of the action in the lucrative Chinese e-commerce space. This is unlikely to change, and because the barrier of entry into the Chinese e-commerce market is high, I believe that the durable advantage, paired with historical trends, and outward looking forecasts largely reinforce Alibaba’s IPO valuation.

Interpreting Yahoo’s Q2 2014 earnings release

On a broader consensus, investors were far from impressed by the quarterly earnings report.  Yahoo shares fell by 5.1% in the following trading session on July 16.

Yahoo stock price movement

Source: FreeStockCharts

The downers from the earnings report primarily came from a miss on expectations. The consensus EPS was $0.38, but Yahoo reported EPS of $0.37 for the quarter. The one cent miss wasn’t the problem; the bigger problem was the guidance on taxes from the Alibaba sale. Investors were hoping that Yahoo could somehow bring the cash back without incurring such a high tax rate.

However, ignoring that small technicality, $6.25 billion in proceeds from the Alibaba IPO after factoring in the taxes, isn’t a small figure to sneeze at. I estimate that if Yahoo were to initiate a $3 billion buyback, the EPS figure could improve by 5-10% year-over-year, which could drive the Yahoo stock valuation even higher.

Yahoo quarterly revenue

Source: Yahoo!

Furthermore, Yahoo’s revenue declined by 4.9% year-over-year. The consolidated performance is likely to improve as Yahoo scales its mobile ad network, and is able to increase pricing and improve engagement across its portfolio of mobile applications. It’s going to be a while before revenue trends turn the corner, but given what Marissa Mayer stated over the conference call, it’s fair to assume that the core business will eventually return to growth. But it won’t happen next quarter, it may happen next fiscal year, as analysts on a consensus basis anticipate sales growth in fiscal year 2015.

According to Ken Goldman, CFO of Yahoo:

For our Q3 guidance we expect the following GAAP revenue – expect the following I should say GAAP revenue range of $1.06 billion to $1.1 billion, revenue ex-TAC in the range of $1.02 billion to $1.06 billion, EBITDA in the range of $220 million to $260 million and non-GAAP operating income in the range of $70 million to $110 million.

The revenue guidance was disappointing, as it indicates that Yahoo won’t grow revenues on a year-over-year basis in the 3rd quarter of 2014. Furthermore, there’s a lot of uncertainty as to whether or not Yahoo will be able to find attractive acquisition targets for the remaining proceeds from the Alibaba IPO sale.

Yahoo stock is a long term buy

I think this quarter was a miss, but it did give us some key insights into Yahoo’s core business. I think that if investors are patient, the stock still holds a lot of value for long-term investors. However, the short-term catalysts could drive the stock price lower.

Going into 2014, Yahoo is likely to return its display-ad business to growth, and assuming that pattern is sustainable, it’s likely that sentiment will improve for the stock. Furthermore, if Alibaba valuation continues to appreciate following the IPO, Yahoo stock valuation will reflect that incremental increase in value, therefore I think it’s premature to write-off the potential of Yahoo!

The recent pullback gives investors a favorable re-entry point.

Alex Cho Alex Cho   on Amigobulls :

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Comments on this article and BABA stock

user profile picture
yahoo only gets the IPO price of 140 million alibaba shares which is $56 for a toatal of 7.8 billion gross but after taxes 5.07 billion and at least 50% of that going to shareholders which comes to $2.50 for each share that shareholders own.
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Virendra Singh Chauhan
At $56 per share, Alibaba valuation comes to 127.5 billion, whereas the author has used a valuation of $150 billion to derive his breakup with regard to payouts to shareholders from the IPO. Payout comes to $3.125 per share and cash available retained also equals $3.125 per share. The remaining 383.6 million shares would be worth $26 billion at a price of $68.75,pre-tax of course. or $26 per yahoo share pre-tax and value of $17 per share post tax. Total value of Alibaba stake could be worth $23.25 ($17 + $6.25) per share, without accounting for Post IPO appreciation of Alibaba stock, which is a very likely event.
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