Many of our readers know Eric Jackson from his appearances on TV and writings around the financial web. Eric is the founder and Managing Partner of hedge Fund IronFire Capital, and for the second time since 2007, he has taken an activist stance towards the management of Yahoo (YHOO). Over the last few weeks, Eric has been very vocal about CEO Marissa Mayer, specifically on her management of the company’s core business, her acquisition strategy, her compensation package and her stock selling plan. I reached out to Eric and he has been kind enough to summarize his thoughts on YHOO for RiskReversal readers:
Yahoo has been a sum-of-the-parts story for the last 4 years. It’s been the core business – for which CEO Marissa Mayer is responsible – the investment in Alibaba (which is supposed to IPO as soon as next month), and the investment in Yahoo Japan (or “YJ” which trades publicly in Japan).
Wall Street sell-side banks have always discounted the value of these investments owned by Yahoo, assuming that one day Yahoo will have to sell them and pay taxes on them.
What you notice currently about Yahoo’s stock price – even though it’s now up 13% in the last month since I started talking openly about how cheap it was – is that, after you subtract out the after-tax values of the Alibaba and YJ stakes, as well as the current Yahoo cash and what they’re expected to get out of their stake sale in the Alibaba IPO, the core Yahoo business is currently only being valued around $500 million. That’s down a lot from 2 years ago when Mayer was hired and the core business was worth about $7.5 billion, after you took out the value of the cash and other stakes.
What’s happened?
Obviously, Mayer’s turnaround hasn’t been very effective so far. Her accomplishments so far include:
- A steady cut of sell-side estimates for Yahoo’s revenues and EBITDA over the last year
- $2 billion spent on Tumblr and dozens of other acqui-hires that currently don’t provide any meaningful revenue and so which get effectively valued at zero by investors
- The hiring and expensive firing of Henrique De Castro
- The unraveling of a sales organization and its steady Eddie legacy display ad business
- A sharp increase in stock-based compensation for Mayer and the rest of the management team
- No meaningful mobile ad revenues which Yahoo is willing to share publicly
- An increase rather than a decrease in headcount
- Recent stock selling by Mayer to the tune of $12 million in the last 6 months
- No clear strategy articulated other than some buzzwords that Yahoo will own “daily habits”
- EBITDA was running at about $1.7 billion annually when Mayer arrived; it’s down to $1.2 billion today
- For all this, Mayer – if she sticks around another 2 years and the stock price doesn’t increase – will get a comp package worth $265 million by my estimates. God bless America.
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So, it’s unquestionable that Yahoo’s increase in its stock price in the past two years is due to the explosion in value of Alibaba, in spite of the deterioration in value of Yahoo’s core business.
Because of Alibaba’s importance to this story to date, some say investors will have no reason to own Yahoo once Alibaba IPOs. I disagree.
As bad as Mayer’s performance has been, at $36/share, Yahoo – the stock – is way too cheap. The core business – even with all its challenges – is still a huge global Internet property with $1.2 billion in EBITDA, lots of fat to cut (further adding billions to the bottom line), and more than a billion dollars worth of real estate they won’t need when they finally “right-size” themselves. The core business is worth at least $5 – 10 billion, which is another $5 – 10/share which you should add to the stock price today.
And what about the future stock buybacks with the incoming Alibaba cash? Yahoo management has already said they’d spend at least half of that on buybacks. But what if they spent all of the $9 billion in cash they’ll have after the Alibaba IPO?
At $36/share, they could buy back 250 million shares or 25% of their float. That “financial engineering would take a $37 billion company today and (assuming the core business actually was assigned a proper value by investors) turn it into $50/share stock overnight.
And what’s especially intriguing for investors is the possibility of Yahoo gaining some tax savings from monetizing their Asian stakes. Yahoo will be on the hook for about $18 billion in taxes or $18/share in value. If either Alibaba or SoftBank (a big owner of Yahoo Japan) was to buy Yahoo, they would reacquire their own stakes and not owe taxes on them. Those tax savings can therefore be shared amongst Yahoo shareholders in terms of the acquisition price paid by either of those two companies. Let’s call it another $10 billion in savings. Saved over Yahoo’s new share count of 750 million, that’s another $13/share either acquirer could pay for Yahoo or $63/share.
And Alibaba or SoftBank would still be getting a huge tax savings themselves.
There’s no other buyer of Yahoo who can realize these kinds of tax savings.
So, as a Yahoo shareholder, which would you rather: a Yahoo run by Mayer where she spends $6 billion on Tumblr-like M&A worth $37/share or a Yahoo taken out by Alibaba or SoftBank for $63/share?
However, Mayer may not want to sell because she’d go from being the CEO of a $37B company to a CEO of a $5B company – or maybe not a CEO at all.
This is where the US system of governance is screwed up: when a CEO with an enormous comp package can hand-pick her board and potentially block a deal which is great for her shareholders but stops the gravy train for her.
So here are Three Catalysts to Watch for in the next few months:
- Alibaba IPO and Where Yahoo Trades: If Alibaba goes out at $150 billion next month and trades up quickly to $200 billion while Yahoo’s stock price stays roughly where it is today or drops, watch for either Alibaba or SoftBank to take advantage of the price arbitrage by making a play for Yahoo.
- Aggressive YHOO Stock Buybacks or more Tumblrs? Is the new Alibaba cash going to burn a hole in Marissa’s pocket until she goes on a Tumblr buying spree for new acqui-hires or is she going to use it all to aggressively buy back stock? If there’s dumb M&A, Yahoo’s stock will get sold off. If there’s prudent stock buying, Yahoo’s stock will jump.
- Nikesh Arora’s start date for SoftBank. The former head of Google sales announced a few weeks ago that he was becoming Vice Chair and head of US Internet Operations for SoftBank. His rumored start date is in October. At present, SoftBank doesn’t have any US Internet Operations – just Sprint. Arora was in the running a couple of times for the Yahoo CEO job. His start date might be the first domino to fall in putting Yahoo in play.
[Disclosure: Eric is Long YHOO]