Latepost Yahoo! A Puzzle, A Mystery In Addition To An Enigma

In my concluding post, I estimated Alibaba's value in addition to concluded that its increment in addition to profitability pose it on a pathway to brand it i of the most valuable IPOs inwards history. In this post, which I thought every bit a companion, I am looking at Yahoo, a companionship that has effectively expire a proxy for Alibaba, specially leading upwards to the initial world offering. To illustrate, Yahoo’s quarterly earnings came out on Apr 15, in addition to it reported apartment revenues in addition to declining earnings. Bad news, right? However, its stock toll jumped on the earnings report, every bit embedded inwards it was skilful tidings nigh Alibaba's revenue increment inwards the concluding quarter of 2013. In fact, inwards the context of valuing Yahoo! inwards my valuation class, I borrowed phraseology from Winston Churchill in addition to described Yahoo! every bit a puzzle, coupled alongside a mystery in addition to wrapped upwards inwards an enigma. Yahoo!, the raise company, is the puzzle (especially inwards how rapidly it lost its authorization inwards the United States, in addition to why), alongside a mystery (its 35% stake inwards Yahoo! Japan, which is prospering piece the raise struggles) in addition to an enigma (the 22.1% portion of Alibaba). 

Note: Press stories approximate Yahoo's holdings at 22.6% or 24%, depending on whether y'all role diluted or primary shares. I used the 523.6 meg shares that Yahoo owns inwards Alibaba in addition to my approximate of 2368.67 meg shares outstanding inwards Alibaba, including restricted stock units, inwards Alibaba to expire far at 22.1%.

Setting upwards the valuation

To value shares inwards Yahoo, y'all withdraw keep to approximate the value of its US operations, but that is entirely a pocket-size slice of the overall value, since Yahoo owns 35% of Yahoo Nihon in addition to 22.1% of Alibaba. Neither belongings is consolidated, in addition to the way inwards which the accounting plant effectively agency that the key operating numbers that y'all run into inwards Yahoo’s fiscal statements (revenues, operating income) volition non reverberate either of these holdings. To illustrate the tangled spider web of values, hither are the steps to larn to the value of equity inwards Yahoo:

Yahoo: The total of the parts

Thus, to value equity inwards Yahoo, y'all withdraw keep to value Yahoo, Yahoo Nihon in addition to Alibaba separately, in addition to afterwards aggregating your holdings inwards each company's equity (100% of Yahoo, 35% of Yahoo Nihon in addition to 22.1% of Alibaba), y'all also withdraw keep to internet out whatever taxes that volition come upwards due on working capital alphabetic quality gains if Yahoo plans to or is required to sell whatever of its holdings. In the example of Alibaba, it has no choice, at to the lowest degree on a part of the holding, since it volition endure required every bit part of a http://www.bloomberg.com/news/2014-02-05/alibaba-s-average-valuation-rises-to-153-billion-after-earnings.html) gain from $150 to $200 billion.

The Bottom line

At this stage, nosotros withdraw keep iii paths nosotros tin follow to approximate the value per portion inwards Yahoo, which entitles y'all to a total portion inwards the parent, 35% of the equity of Yahoo! Nihon in addition to 22.1% of the equity inwards Alibaba. In each case, I withdraw keep netted out the taxes that Yahoo volition withdraw keep coming due on the 208 meg shares of Alibaba that it volition withdraw keep to sell. Pulling together the numbers for all the valuation/pricing of the private companies, hither is where nosotros stand:

1. All intrinsic value: Using the intrinsic value estimates that nosotros withdraw keep for the iii companies inwards the mix, nosotros tin approximate an intrinsic value per portion for Yahoo:

The taxes were computed based on the working capital alphabetic quality gains, the deviation betwixt the assessed equity value for Alibaba in addition to the mass value (from Yahoo's 10K) for these shares. Using intrinsic value estimates for all iii companies, the value per portion is $41.19, making it nether valued past times 18%, relative to the prevailing toll per portion ($33.76).
2. All relative value: Using the relative value estimates that nosotros withdraw keep for Yahoo, Yahoo Nihon in addition to Alibaba, nosotros derive a relative value per portion for Yahoo:

On a relative value basis, the value per portion is $39.19, making it nether valued past times 14% at its electrical flow price.

3. Pricing break-even: There is a tertiary twist that tin endure used to value Yahoo's equity. You tin role the marketplace pricing of Yahoo Nihon in addition to Alibaba to dorsum out the value that the marketplace is attaching to the raise company's operating assets. Since Alibaba is non world yet, this volition require role of the estimated IPO value numbers (I volition role $150 billion for the base of operations case), but in i lawsuit Alibaba becomes a world company, the pricing volition endure the marketplace value.

Using the expected IPO value of equity of $150 billion, the determination y'all expire far at is that the marketplace must endure attaching a negative value to the raise company's operating assets. To the extent that this may merely reverberate the possibility that nosotros are misplacing the Alibaba IPO, I estimated the value of Yahoo operating assets every bit a component subdivision of the value of Alibaba equity afterwards the IPO.

Imputed value versus Intrinsic value

The results hither are consistent alongside both the intrinsic in addition to relative value assessments. Unless the Alibaba post-IPO equity value is less than $104 billion, it looks similar Yahoo is mispriced, relative to how its holdings are beingness priced. 

What next?

While I rest concerned nigh the overall valuation of companies inwards the sector, Yahoo seems mispriced on every basis, intrinsic, relative in addition to marketplace pricing. I am aware that in that location are risks (as alongside whatever investment) in addition to in that location are iii concerns that I have:

1. Cross belongings complexity: Yahoo is a example study inwards why valuation becomes hard inwards the presence of cross holdings. In particular, the accounting for cross holdings, though it has its ain internal logic, creates inconsistencies across fiscal statements that both confuse in addition to trip upwards investors. In the example of Yahoo, the cross holdings inwards Yahoo Nihon in addition to Alibaba are recorded using the equity approach. The internet resultant of the accounting is that the operating numbers for Yahoo (revenues, EBITDA in addition to operating income) reverberate aught from these holdings whereas the internet income in addition to mass value of equity do reverberate the cross holdings . So what? For those investors who are subject upon firm value multiples (EV/EBITDA or EV/Sales), applying either of these multiples to Yahoo numbers, adding cash in addition to subtracting debt, i.e., next conventional practice, volition yield a value of equity far lower than the marketplace capitalization of the companionship because y'all are effectively attaching no value to its cross holdings. It is truthful that y'all may endure able to role internet income every bit your base, since it includes the income from the cross holdings, in addition to apply a PE ratio to it, but that PE ratio volition withdraw keep to reverberate the composite expectations across iii companies (Yahoo, Yahoo Nihon in addition to Alibaba) on increment in addition to risk.
2. The taxation seize alongside teeth may larn larger: I withdraw keep assumed the minimum taxation seize alongside teeth inwards my valuations, since it actually makes no feel for Yahoo to liquidate its cross holdings now, unless it is forced to, every bit it is inwards the example of the 9% of Alibaba that it has to sell. It does non need the cash, its investors should larn the pass-through value in addition to it sure as shooting does non desire to pay the taxation pecker early. There are 2 scenarios, though, where this supposition may interruption down. First, if the marketplace prices for Yahoo Nihon in addition to Alibaba skyrocket in addition to Yahoo's toll does not, the gap that nosotros highlighted inwards the concluding department may larn bigger. In fact, if it gets large enough, Yahoo may endure forced to monetize the gap, i.e., sell its holdings inwards Yahoo Nihon in addition to Alibaba, pay the taxes, in addition to yet withdraw keep coin left over for its stockholders. The minute relates to Yahoo's human relationship alongside Alibaba. It is possible that Alibaba may endure uncomfortable alongside Yahoo's continued large stock ownership in addition to uncovering a way, legal or extralegal, to larn Yahoo to sell. 
3. The "do something quickly" discount: There is a bias both amidst analysts in addition to fiscal journalists towards CEO activeness over inaction, towards quick activeness over to a greater extent than deliberate choices in addition to towards increment over retrenchment. Leading into the Alibaba IPO, in that location has been a drumbeat of articles similar this one and this one that are total of advice for Ms. Mayer nigh what she should do alongside the cash windfall that Yahoo volition withdraw keep afterwards the IPO. Most of these articles propose ways inwards which Ms. Mayer tin role the cash to supply Yahoo to its glory days. I retrieve that Yahoo has lost the larn by to Google in addition to should concede gracefully. Rather than throw skilful coin afterwards bad, my proposition is that Yahoo do the following: (a) concede that increment inwards its center concern volition endure likewise expensive to expire after, cutting dorsum on increment investments in addition to run itself every bit a mature concern (essentially what I withdraw keep assumed inwards the intrinsic valuation), (b) function on making the performance in addition to the pricing of its cross holdings to a greater extent than transparent to investors in addition to (c) supply the excess cash to investors. The upside of doing this volition endure that the gap betwixt toll in addition to interruption upwards value may shrink, benefiting stockholders. The downside is that Ms. Mayer loses a peril (albeit i alongside depression odds) to expire downward inwards history every bit the CEO who brought Yahoo dorsum from the dead.

The cross holdings in addition to the confusion they breed amidst investors it both an ally in addition to a hindrance, an ally because it is i argue why the stock (in my view) is mispriced in addition to a hindrance because it may accept a piece for the mispricing to expire evident. Alibaba's IPO may seem an obvious catalyst but marketplace corrections don't ever follow the logical path. The taxation number is a nagging problem, but the companionship seems cognizant of the taxation overhang in addition to negotiated alongside Alibaba to cut back the number of shares that it would withdraw keep to sell afterwards the IPO. Finally, Ms. Mayer seems to endure maxim all the right things, talking nigh how how she plans to endure a "good steward of capital", but verbalize is inexpensive in addition to the pressure level to expire for bigger in addition to improve volition endure hard to resist. On balance, none of these risks is plenty of a bargain breaker for me. Not entirely is in that location a gap betwixt toll in addition to value alongside Yahoo but in that location is i betwixt toll (that the marketplace is attaching to Yahoo) in addition to toll (that the marketplace is attaching to Yahoo! Nihon in addition to Alibaba) in addition to every bit a newly minted Yahoo stockholder, I am hoping that i or the other of these gaps volition close.

Yahoo! Equity Valuation: Master spreadsheet (is linked to private companionship valuations below)

Yahoo! Parent intrinsic valuation

Yahoo! Nihon intrinsic valuation

Alibaba IPO intrinsic valuation

Raw information for relative valuations (Online companies - fundamentals in addition to multiples)