Description

Yahoo!, YHOO, was mismanaged for several years leading up to the failed MSFT takeover, the recent management change and restructuring.  These events have created some interesting catalysts in a very cheap stock that still has some very valuable properties and is now operationally turning a corner. 

Management has a renewed focus and a well articulated strategy for growing revenues and increasing operating margins.  Management expects to accelerate revenue growth through 2012 and increase operating margins to 15-20% in 2012, up from 7.9% in 2009, excluding restructuring.  Incidentally, in 2005 operating margins were 21%.

The main driver of operating margins is the MSFT partnership that began on 2/23, which is beginning several months earlier than originally anticipated, and which was announced last July of 2009.  YHOO is now outsourcing its search function to MSFT, so that Bing is the search backbone.  YHOO still has access to the user and usage data.  YHOO is also transferring 400 employees over to MSFT and MSFT is paying YHOO rebates for the operating expenditures associated with search until the transition is complete.  This could save YHOO $425 million/year.  This also suggests that if the MSFT partnership runs smoothly and the transition happens on schedule that YHOO could be close to the lower end of its operating margin target for 2012, by the end 2010. 

YHOO's operating structure has become very inefficient over the years also.  There are ample opportunities to rationalize operating divisions and cut costs.  For example, YHOO runs 33 sets of code bases on its home page and runs two separate ad platforms, both of which will be consolidated in 2010.

YHOO also has several initiatives to improve monetization and pricing.  The most important of these is the network distribution initiative that gives advertisers more control over how and where they spend search dollars on YHOO, which prior to January of 2010, they had no control over.  This should lead to great percentage of budgets directed towards O&O properties, which deliver better economics.  This will probably have a negative impact on the affiliate network, but this should be more than offset by the gains.  These changes, among others, will lead to better ROI's for advertisers and better pricing for YHOO.

In February of 2010 YHOO lost 20bps of market share in US search, falling to 16.8%.  Bing has been growing rapidly though, at 55%, so its share was up 20bps to 11.5%, so combined they have 28.3% share v. GOOG at 65.5%.  So while these statistics are not great, they do show some signs of stabilization for YHOO.  The general economic recovery is also helping advertising across the board, but seems to be really boosting display advertising, where YHOO is strong, so these trends should also be positive for YHOO's top line.

Although YHOO has not been managed well over the past few years and their share of search has fallen, it still has some of the strongest properties on the internet, which if they were better managed could be leveraged and monetized on a much larger scale.  For instance, YHOO has $10 billion of ad impressions every day.  Its new, sports, finance, and entertainment verticals have about 80 million unique visitors every month.  And YHOO users send over 110 billion emails per month.  Another area with a lot of potential improvement is that 75% of its users are from international regions, yet only 27% of its revenue is.  Mobile also has a lot of room for development.

If we assume that YHOO can grow revenues at a mid single digit rate through 2012 and achieve 15% operating margins, YHOO could generate revenue and EBITDA (excluding stock based compensation) of $7.1 billion and $2.1 billion in 2011, and $7.5 billion and $2.4 billion in 2012.

YHOO also has several very valuable Asian assets.  The largest is Yahoo Japan, which YHOO owns 34% of, which is worth US$ 5.3 billion, after a 30% discount for liquidity and taxes.  YHOO also owns a 40% interest in the Alibaba group.  The largest portion of this is Alibaba.com, which is publicly traded in Hong Kong and worth about US$ 2.2 billion.

The other companies in Alibaba Group are harder to value since they are private.  The two most valuable are Taobao, which is the leading e-commerce site in China, and Alipay, which is the largest online payment processor in China.  According to GS (so take this with a grain of salt, if you will), the gross market value of Taobao transactions was US$ 29.3 billion, which resulted in US$ 249million of revenue.  They expect transaction value to grow to US$ 117 billion in 2012, generating US$ 1.8 billion of revenue and US$ 350 million of operating income.  Taobao also has over 100 million registered users. Alipay is generating over US$ 40 billion in payment volume and has 190 million registered users.  I think these two assets are conservatively worth over US$ 2 billion together.  Alibaba Group also owns Alibaba Cloud Computing and China Yahoo, which I am ascribing no value to.

In total, YHOO's Asian assets are worth conservatively US$ 9.6 billion, or about $6.77/share.  Certainly the Alibaba assets could be worth less than this, but they will end up being worth a lot more, especially if compared to other fast growing Chinese internet companies, like BIDU, and Taoboa is expected to come public in 2011, which could unlock a lot of value.  And my estimates for Alibaba.com and Yahoo Japan's valuation could be conservative also because of the partnerships and international tax regimes, YHOO might potentially be able to monetize those in a much more shareholder friendly fashion, although management has said they have no intention of liquidating these assets.  Without taxes and liquidity discount these assets are worth US$ 12.8 billion, or $9.05/share.

Based on conservative valuation of the Asian assets and conservative estimates, YHOO is trading at about 6.5x 2011 EBITDA and 5.5x 2012 EBITDA.  I think the stock is worth mid 20s at least.

Also, note I have given not given YHOO credit for its long term marketable debt securities.  Including these cash would be $4.5 billion.

YHOO also has a buyback and could divest more assets, like Hotjobs.

Investing in YHOO is not without its risks.  Historically, technology turnarounds do not have the best success rate, and in technology there are always risks like the rapid pace of innovation and obsolescence, which makes it difficult for most companies to have a sustainable competitive advantage, as well as cyclical risks to advertising, if the economy fails to recover further.  There are risk specific to YHOO as well, like declines in search could continue and the potential for competitive threats to display advertising from social networking sites. 

Catalyst

MSFT partnership, improving operational trends, improving economy, Taoboa IPO