How to Play the Yahoo! Inc. (YHOO) Acquisition Rumors: Zynga Inc (ZNGA), OpenTable Inc (OPEN)

If we look at the acquisition habits of internet-based companies, most prefer acquisitions of private companies. The primary reason is because internet-based companies are very expensive to acquire because of market valuations. For example, OpenTable Inc (NASDAQ:OPEN) trades with a price/sales ratio of 8.88 and saw 15.6% sales growth its last quarter. Therefore, despite the fact that Yahoo could integrate the business on a much larger scale, and grow it faster, it would take many years to ever pay off. For example, if Yahoo! Inc. (NASDAQ:YHOO) acquired OpenTable for a 50% premium, around $2.1 billion, and could maintain top-line growth of 20%, and profit margins of 15%, it would take almost 15 years for the OpenTable Inc (NASDAQ:OPEN) acquisition to return a profit from net income. Then, you have to worry if the business model can sustain itself in the ever-changing social media space.

Bottom Line

A couple months ago, I had a book published, Taking Charge With Value Investing (McGraw-Hill, 2013), and my goal of writing the book was to use my specialty and to explore market psyche, and to explain how the market behaves and how to capitalize on illogical trends and outlooks to return gains. In the book I show that one of the greatest opportunities in the market is when acquisition rumors begin, because very rarely do they ever materialize or appreciate to the expected price. Therefore, the natural behavior of retail investors is to buy in hopes of quick gains, but shorting on acquisition rumors has been the best trade for the last five years.

I might add that I’m not saying none of the four companies above will be acquired. However, when it really comes down to it, companies and CEOs such as Yahoo and Marissa Mayer are smart, and realize the length of time that it takes for a high-profile internet-based acquisition to pay off in terms of profit. They also know that in social media, only a handful of companies will last longer than 15 years, and most companies learned from the dot-com debacle of 2000.

With that being said, I think it is very unwise to invest in one of the four companies above on the prospects of a potential acquisition. If you believe in the long-term fundamental prospects and believe one is priced attractively to the market, then invest. But more than likely, Yahoo! Inc. (NASDAQ:YHOO) will continue the trend of purchasing private companies, and there will be a number of investors upset with their lack of return, and their ultimate loss.

The article How to Play the Yahoo! Acquisition Rumors originally appeared on Fool.com and is written by Brian Nichols.

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