As an investor, there is no company I’ve invested in that has been quite as exciting as Yahoo! Inc. (NASDAQ:YHOO). Everything from Alibaba drama to resume-gate has made Yahoo the technology industry version of a soap opera. Yahoo! is trading near a five-year high. At this point in time, however, I believe it is important to see where Yahoo! goes from here.
Bull case for Yahoo!
Even with a stagnant core business, using a sum-of-parts valuation, Yahoo! Inc. (NASDAQ:YHOO) could have room to grow. Yahoo!’s 35% stake in Yahoo Japan is worth $9.4 billion. Yahoo! also has $4.8 billion in cash. Making up the rest of the valuation is Yahoo!’s 23% stake in Alibaba Group and its core business.
Theoretically, let’s assume Yahoo! is able to unload its Alibaba stake and Yahoo Japan stake with a tax rate of 36%. This is approximately the tax rate Yahoo! got on the $6.8 billion it received in the last monetization deal. Using $100 billion valuation for Alibaba Group this adds up to $20.7 billion ($32.4 billion * 64%). Adding in $4.8 billion in cash, Yahoo! Inc. (NASDAQ:YHOO)’s core business makes up the remaining $5.5 billion of market cap. This is an extremely cheap valuation for a core business generating over a billion in earnings every year.
Marissa Mayer’s experience at Google Inc (NASDAQ:GOOG) has changed Yahoo!’s approach in building its business. Google has dominated the online advertising industry by first engaging users with its products. Yahoo! is now emulating this approach. While Yahoo! Inc. (NASDAQ:YHOO) missed on revenue expectations, it is important to note that in its recent earnings call Google Inc (NASDAQ:GOOG) also missed due to downward pressure on advertising prices. Growth of both Google Inc (NASDAQ:GOOG) and Yahoo!’s core business will be dependent on how they deal with this pressure.
Risks unloading Asian assets
On the other side, however, Yahoo! is priced high enough that there is not much of a cushion if it struggles to monetize its Asian assets.
There were reports nearly two years ago that Softbank and Yahoo! Inc. (NASDAQ:YHOO) were close to a deal for the sale of the Yahoo Japan stake. This deal has yet to materialize.
There are also risks associated with Alibaba’s valuation. Less than a year ago a round of funding valued Alibaba at $35 billion. As little as five months ago the median price estimate for an Alibaba IPO was at $62.5 billion. This represents a nearly 300% increase in under a year. Not surprisingly, Alibaba has made attempts to temper expectations so as to not have an IPO similar to Facebook, which lost 50% after its IPO.
A feature of Yahoo! and Alibaba’s recent deal details future monetization of the stake. It guarantees the right, in case of an IPO, to sell another quarter of its stake to Alibaba at IPO price or sell it at the IPO. That’s only 10%, or half of its current stake
The risk of Alibaba coming out a cheaper valuation than current estimates is compounded by the risk of Yahoo! Inc. (NASDAQ:YHOO) not being able to shed the entire stake. If Alibaba thinks its IPO price is on the high end it is unlikely to purchase more than the required amount of Yahoo!’s remaining stake. A valuation in the range of $60 billion, which would still be the highest of all Chinese technology companies, could shed as much as $6 billion in the valuation I detailed above. This means the story needs to be on Yahoo!’s core business.
