Description

Investment Thesis

We recommend buying shares of YHOO stock, which we estimate to be trading at 3% below a fully-taxed valuation of all of its pieces.  We estimate 17%-22% upside in our sum of the parts.  We view Yahoo as a relative conservative merger arb play with considerable margin of safety at current levels.  Applying a 20-25% discount to the BABA shares and 40% to the Yahoo Japan holding, suggests the core business is worth negative $0.60 to negative $2 per share.  We believe the core business, real estate and associated IP can be monetized on an after-tax basis in the range of $4.55-$5.45 per share; this could take place over the next six to nine months.  After these events unfold, the market will be forced to place an appropriate valuation on the remaining assets – BABA, Yahoo Japan and the cash.

The best way to head China exposure and capture the market’s undervaluation of the core business is to short out the company’s holding in Alibaba Group.

Why does the opportunity exist?

We believe Yahoo’s discounted valuation is due to a number of factors

1) severe deal fatigue with the long running Yahoo saga

2) blow ups in event driven funds

3) overall widening of spreads associated with recent market volatility

The affirmation that yahoo is running a process suggests the timing is finally right to own the stock.  AOL CEO Tim Armstrong has been seeking a merger with Yahoo for many years and we believe Yahoo has several key brands that have significant strategic value (Sports, Finance, etc.)  Moreover, Armstrong has proven that he is more than capable of rescuing dying brands and Yahoo has a lot more to work with than Armstrong inherited at AOL in our opinion.  While it is not a fait accompli that Verizon acquires Yahoo’s core business, we believe Verizon to be the best buyer.  We do not believe the process will be a firesale and believe there is potential for an upside surprise (though we are not counting on it.)

https://investor.yahoo.net/releasedetail.cfm?ReleaseID=955792

AOL as a comp

-AOL was acquired for $4.4 billion.  Adjusting for cash on hand at the time of the merger announcement, the deal price was $3.925 billion or roughly 20x 2015E EBITDA for the brands and platform assets (after backing out the dial-up/membership business at 5x).   

-AOL’s membership business (largely consisting of the legacy dial-up business) generated 80% of pre-corporate EBITDA in 2014

-During the AOL strategic process, Verizon and other third party bidders demonstrated ZERO interest in acquiring the membership business.  Strategic interest was placed wholly on AOL Brands and Platforms.

-We estimate AOL Brands and Platforms generated about $100 million in EBITDA in 2015.  Our math indicates that VZ paid roughly 20x EBITDA for the brands and platform assets (and Tim Armstrong and team).

-We believe the AOL comparison is relevant in so far as Yahoo has a number of assets that continue to remain highly relevant today.

Thoughts on Yahoo’s Core Business

-Yahoo’s rationalization plan is about five years late in coming although it is a step in the right direction

-Consensus 2016 EBITDA estimates for the core business are $746 million

-Management guidance is for a roughly 10% decline in GAAP revenue to $4.4 billion to $4.6 billion and $700-$800 million in EBITDA (down from $952 million in 2015).  The company is targeting cost savings of $400 million for the year. 

-The plan calls for $1 billion of run-rate adjusted EBITDA in the second half of the year (reflecting the full impact of the cost rationalization plan)

-After the cost reduction plan is fully implemented Yahoo will be down to a handful of brands – Finance, News, Sports, and Lifestyles – and three platforms Search, Mail and Tumblir.  Advertising technology offerings will include Gemini and Brightroll.

-We believe consensus EBITDA estimates of $746 million are reasonable.

https://investor.yahoo.net/releasedetail.cfm?ReleaseID=952996 

Other Assets (Real estate, IP, etc.)

Yahoo management estimates that it can generate $1 to $3 billion from the sale of non-strategic assets, including patents, real estimate and other assets.

Valuation of Yahoo Core - $4.3 to $5.2 billion

Excluding net cash, we believe that Yahoo core assets can be valued on an after-tax basis at $4.3 to $5.2 billion.

-We value the real estate, patents and related assets at the midpoint of managements expected monetization range - $2 billion

-At the low end, we believe the core business can sell for 6x consensus 2016 estimated EBITDA ($746 million) or $4.5 billion.  This implies a 1x EV/Sales multiple for the business or 4x management’s estimate of 2016 2H run-rate EBITDA.

-At the high end, we apply the same 6x multiple to the $1 billion targeted 2H:16 run-rate EBITDA or $6 billion, which works out to 1.3x revenue.

-Assuming $1 billion in cost basis for the assets (which we believe to be quite low based on prices paid for Tumblir, Brightroll and other recent acquisitions) and a 40% tax rate, we arrive at after-tax valuation ranges of $4.3 to $5.2 billion   

Sum-of-the-Parts Valuation In both scenario 1 and 2, we believe that YHOO will be able to avoid taxes on its stake in Alibaba.  We believe that Alibaba will ultimately acquire the residual “BABA/Yahoo Japan Co.” at some point and we expect BABA to extract some value in doing so in tax-free deal.  The deal would be expected to be a share for share exchange (similar to the Liberty Media Entertainment/DirecTV share swap) where Alibaba in effect buys its own shares at a discount.  Tax experts have previously suggested that Yahoo’s planned spin-off of BABA shares would likely trade at a 10-15% discount.  We have been more conservative in our assumptions below, reflecting the fact that BABA will not be completely isolated – at least initially.

Alibaba Group (BABA).  We value Yahoo’s 384 million shares of BABA at the current market price ($68.84).  Current market value on a pre-tax basis is $26.4 billion. In scenario 1, we apply a 25% discount to this holding, valuing the shares at $19.8 billion or $20.85 per YHOO share.  In scenario 2 (base case), using a 20% discount, the BABA shares are worth $21.1 billion or $22.25 per share.

Yahoo Japan (4689 JP).  In both scenario 1 and scenario 2, we apply a 40% discount to Yahoo’s 2 billion shares of 4689 JP, which are currently trading at 445 Yen.  With the recent rally in the Yen to 112 currently, the Yahoo Japan stake is valued at $8 billion pre-tax and $4.8 billion ($5.05 per share) reflecting tax/illiquidity discounts.  

Net cash and marketable securities.  We value net cash at 100 cents on the dollar.  Yahoo ended the year with $5.6 billion in net cash, roughly $5.90 per share.

Core business.  As per our analysis above, the core business (excluding net cash) is valued at $4.3 billion (scenario 1) to $5.2 billion (scenario 2) on an after tax basis, $4.55 to $5.45 per share, respectively.

Adding the pieces together we arrive with upside potential of 17%-22%.  

Catalyst

Progress in sale of core business

Monetization of real estate/IP