$YHOO Q2 Earnings Preview

by Enis July 15, 2014 10:47 am • Commentary

Event:  YHOO reports Q2 earnings today after the close.  The options market is implying about a 4.5% move, which is below the 4 qtr avg move of 6.5%, and in line with the 8 qtr avg of about 4.5%.

Sentiment:  Wall Street analysts are relatively bullish on YHOO, with 23 buys, 14 holds, and 1 sell.  There have been several upgrades over the past 3 weeks as analysts have become more optimistic ahead of the Alibaba IPO (there were 19 buys, 18 holds, and 1 sell 3 months ago).  The average 12 month price target is $41.  Short interest is around 3% of the float.  YHOO is down 12% year-to-date.

Options Open Interest:  Total open interest is heavily skewed towards calls over puts by a ratio of about 2.1 to 1.  Similarly, the one month average volume is also skewed to calls over puts, by a ratio of 2.3 to 1.  The Jul19th 38 call strike and the Aug16th 35 call strike both have over 40k of open interest, the most among short-dated maturities.  In Jan15 expiration, the Jan15 40 calls have over 160k of open interest, by far the most for that expiry.  On the put side, the Jan15 30 puts have nearly 50k of open interest.

Fundamentals:  YHOO has been viewed as a sum-of-the-parts story by traders for much of the past 2 years.  I laid out the value of the parts in a Name That Trade post on June 6, detailing the potential valuation for the stock in various scenarios:

The sum-of-the-parts analysis of YHOO looks like this:

-$6-$7 per share of value from Yahoo Japan

-$14-$28 per share of value from Alibaba (with $14 corresponding to about a $100 billion valuation, and $28 corresponding to about a $200 billion valuation)

-$4 of value from cash on YHOO’s balance sheet

-wherever you value core business (generally ranging from $5-$15)

So the very bullish case on YHOO is for a share price of $54 based on sum-of-the-parts, while a bearish case would be a share price of $29.  Looks like an obvious long right?  But it’s not so simple.  First of all, stocks rarely trade at the full value of their parts.  Second, activist investor Dan Loeb, who recognized the value of these parts when the stock was $13.50, sold most of his shares at $29.11 last year, one indication of fair value from a savvy investor.

The near-term wild card of course is Alibaba.  Since the value of YHOO’s stake will remain unknown until after Alibaba shares start trading in August or September, I would expect YHOO to remain between $32 and $40.

Besides the valuation of the Alibaba stake (which is likely to be known on the Aug. 8 IPO), the value of Yahoo’s core business is also debatable, though it’s a smaller piece of the pie than Alibaba.

Dan discussed the risk that YHOO mismanages its cash after its coffers are filled from the Alibaba IPO in the June 25 MorningWord:

For the last ten years the knock on Yahoo was that it was a has been as far as innovation and its ability to attract talent was impossible as the most skilled programmers were drawn to Google, Facebook and almost every other mobile startup.  Yahoo CEO Marissa Mayer has stated on many occasions that Yahoo has gotten its mojo back and resumes from the best and brightest have been flooding in.  Maybe that’s the case, but I am not sure Mayer trying to replicate the startup culture from over a decade ago at Google is going to do the trick. Making lots of patchwork acquisitions while making a bunch of 20 something hipsters very rich and then trying to integrate their nascent technologies and their personalities part of Yahoo’s culture may be a tall task.

Up to this point, Marissa Mayer has likely been more of a beneficiary of Alibaba’s success rather than her own management prowess.  Those buying the stock here are likely betting on better strategic decisions than management has made in the recent past.

Price Action / Technicals:  YHOO continues to exhibit rangebound behavior ever since the stock fell down to its 200 day moving average in April for the first time since the summer of 2012:
YHOO daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg
YHOO daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg

Since YHOO’s slight break above $40 in late Dec / early Jan, YHOO has traded between $31.50 (in green) and $40 (in red), and is now in the middle of that range.  The 50 day ma is flat, while the 200 day ma is still rising.

We still expect rangebound price action in YHOO for the reasons laid out in our Name That Trade post in early June.

Volatility Snapshot:   

YHOO is one of the few stocks where 30 day implied volatility is near a 2 year high:

YHOO 30 day implied volatility, Courtesy of Bloomberg
YHOO 30 day implied volatility, Courtesy of Bloomberg

That’s quite incredible considering the low volatility backdrop for the rest of the market.  However, YHOO’s options prices have increased as a result of the Alibaba IPO on August 8th.  The road show is expected to offer many headlines as well, so options are bid more in anticipation of the Alibaba IPO process and completion rather than the earnings event on Tuesday (evidenced by the 4.5% implied move for earnings).

Our View:  We have had a rangebound view on the shares for more than a month, though are a bit bummed that we didn’t pull the trigger on a trade to express that view.  At this juncture, while implied volatility is quite elevated, the stock is at more risk of making big moves over the next few weeks as the headline risks related to the Alibaba IPO become more acute.  We’ll hold off on a short volatility trade ahead of earnings, though we might put on a new trade if YHOO nears either end of the 6 month range ($32.50 or $40).