A little over a year ago here in Forbes, I wrote a post about how Yahoo! was going to go to $40 by the end of 2013.
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It turns out that was a very accurate call, as the stock now trades slightly above the $40 level.
I recall a year ago when I wrote the post, Yahoo's stock was trading just above $17. It had enjoyed a slight rise in price since Marissa Mayer was hired as CEO in July 2012.
However, you could find few bullish investors or pundits on Yahoo at the time. In fact, I recall many pundits — including several on business TV — saying that “the easy money had been made on Yahoo” and that “Dan Loeb had caught lightening in the bottle” with the stock’s move from $11 (when Dan initially bought shares and the move to $17) but that this levitation wouldn’t last. All these wise prognosticators suggested that you sell your shares at that time.
In hindsight, it’s obvious what all these folks got wrong in predicting Yahoo’s stock price. They believed that Yahoo’s stock price was greatly dependent on how Yahoo’s core business performed.
It turns out, this part of the business accounted for perhaps 15% of the change of Yahoo’s stock price in the past year.
The bulk of Yahoo’s 100% increase in stock price this year was due to the growth in the perceived value of Yahoo’s 24% stake in Alibaba. It didn’t hurt that Yahoo Japan doubled in price too and that Yahoo owns 35% of that business.
In my own analysis from last year’s Forbes post, I certainly was a believer in Yahoo’s Asian assets and did correctly tell people to ignore the core business and pay more attention to the growing value of these assets. But even I didn’t guess that Alibaba would grow in perceived value so quickly. I thought that Alibaba would be worth $60 – 70 billion by now. Most analysts think it’s worth $100 – 170 billion today.
I believed that, even with a lower Alibaba valuation, that Yahoo could get to $40 by this time through more aggressive stock buybacks and a cash-rich split scenario. It turned out that neither of those happened. Yet, they remain as intriguing possibilities going into 2014.
Today, Yahoo’s worth over $41 billion. The natural question is where it goes from here.
You certainly have a lot more positive commentators about Yahoo these days. The bulls say you have to stick with it because of the potential value of Alibaba once it IPOs. However, you still have lots of negative Nancy’s (like the Wall Street Journal’s Heard on the Street column — which has been negative on Yahoo throughout its rise in the past year) who believe that the easy money has now been made and it’s time to leave the Yahoo party.
Although I had believed $40 would be a great price point to think about exiting my Yahoo trade, I’m sticking with it in 2014 as I think there’s still lots of upside ahead.
Yahoo still owns 24% of this company. It hasn’t yet IPO’ed but probably will before June. Most think it’s worth between $100 – $170 billion today. Let’s assume it IPOs at the low end of that valuation for $100 billion. At the time of the IPO, Yahoo will reduce its stake from 24% to 14%. Therefore, they will get $10 billion in proceeds from the sale or let’s say $6.7 billion after taxes.
They’ll continue to hold 14% of Alibaba which will likely quickly be worth the $170 billion valuation, making Yahoo’s stake worth $23.8 billion or $16.2 billion after taxes.
Yahoo owns 35% of this business which is worth $11.2 billion today or $7.6 billion after taxes.
In all likelihood, this stake is going to go up this year. It probably won’t double but a 50% gain in YJ’s shares is likely in my view. That means Yahoo’s stake will be worth $16.8 billion gross or $11.4 billion net of taxes.
Japanese Yen Hedge Paying Cash:
Although some people paid attention when Dan Loeb pushed Yahoo’s board to buy a large futures contract a year ago betting that the Japanese yen would weaken over the next year, most seem to have forgotten. Yahoo put those hedges on when the yen was trading around 80 cents to the US dollar. It’s now $1.05.
And guess what? Starting this quarter (Q4), those contracts will start to payout cash to Yahoo. The payouts will likely continue for the next 6 quarters.
How much are they worth? We don’t know for sure and it depends on where the yen continues to go from here as future contracts expire.
But it’s safe to say it should be at least $1 billion this quarter and probably $4 billion net of the weakening value of Yahoo’s YJ stake due to a lower yen.
Yahoo still has over $3 billion in cash on its balance sheet today and has historically been operating cash flow positive.
Yahoo Core Business:
For 2013, Yahoo’s expecting to do $1.5 billion in EBITDA. Next year is anybody’s guess. The bears think it probably should stay the same or decline next year. The bulls – like me – think it should actually go up if Marissa’s efforts to turn around the business actually start to pay off, including monetizing the Tumblr property.
I think $2 billion in EBITDA is likely but there’s an outside chance it could reach $2.5 billion.
Most Internet businesses get an 11x EBITDA multiple. I think Yahoo’s been getting something like a 4 – 5x multiple for a long time.
What should it get? Well, AOL gets 8.3x currently and I believe Yahoo’s worth a slight premium to AOL. Let’s say 8.5x. That suggests Yahoo’s core business should be worth $21.3 billion today.
If you add up the expected value of Alibaba, YJ, Yahoo core and its cash at the end of 2014, you get a grand total of $62.6 billion.
With roughly 1 billion shares outstanding, that suggests Yahoo will be worth $62.50/share by the end of the year.
Additional Stock Buybacks:
But will Yahoo just sit with the excess cash on its balance sheet? It’s unlikely. They’ve already authorized an additional $5 billion in stock buybacks.
With the Japanese yen hedge, proceeds from the Alibaba IPO and existing cash, Yahoo will have $13.7 billion in cash on its balance sheet by year end. Assuming they want to keep their $3 billion in cash cushion as CFO Ken Goldman has said, that means they’ll have about $10 billion to do stock buybacks this year, more than their current $5 billion plan.
Let’s say they want to keep some of that for M&A and say they’ll have $8 billion for stock buybacks.
Let’s say they do those buybacks between a range of $40 – 55/share (as the stock will presumably rise throughout the year and they’ll space it out over time). That gives us a cost basis of $47.50/share. For that, they could retire 168 million shares.
This would bring down their outstanding shares to 832 million shares. Adding up their remaining cash (the base case $3 billion plus another $2.7 billion which they’ll probably spend on M&A which presumably will add some value), core, YJ and Alibaba stakes, you get to a year-end 2014 stock price for Yahoo of $65.63/share.
Possible Cash-Rich Splits:
I’ve spoken several times in Forbes and elsewhere about the potential value to Yahoo investors of doing a cash-rich split to monetize their stakes in Alibaba and/or YJ.
Now, to be clear, I’m happy that Yahoo’s done nothing with those stakes to date. They’ve both been phenomenal investments — all deserved credit to Jerry Yang.
But by the end of 2014, I believe it could certainly make a lot of sense to monetize the YJ stake. The Alibaba stake seems like something worth hanging on to longer term as it starts to expand into international markets.
In a cash-rich split, two parties swap assets, so it is a tax-free transaction. If one party (YJ) is giving some cash for the asset it’s getting back (Yahoo’s 35% stake in YJ), it can still be a tax-free transaction as long as the cash is no more than two-thirds of the total value of the swap. The remaining assets going back to the other party (Yahoo) can’t be cash. So YJ could buy a company and pass it over to Yahoo along with the cash in exchange for the 35% stake back. That deal is a cash-rich split.
Why would YJ want to do it? Because the moment they do, they get to retire 35% of their shares and their EPS estimates go sky-high along with the value of the remaining stock. It’s a win for Yahoo and YJ.
So what could the other asset coming back to Yahoo be in the scenario where Yahoo’s gross stake in YJ is worth $16.8 billion at the end of the year. Well, one-third of that price is $5.6 billion. What Internet asset might Yahoo want which Yahoo Japan could buy for $5.6 billion with a nice premium built into it? I don’t know for sure but the asset I think makes a lot of sense is AOL which currently has a market cap of $3.6 billion.
Another possibility that I think is intriguing is what if Yahoo bought Microsoft’s Bing search engine and then licensed it back to Microsoft for exclusive use?
Whatever “other asset” Yahoo gets back, it’s probably another $5 billion in value that Wall Street is currently not building into Yahoo’s price estimate. That’s another $6/share which could find its way into Yahoo’s stock price by the end of the year. That’s over $70/share by the end of 2014.
Now, to get to $70/share by the end of 2014, a lot of things have to go right. The core has to turn around, there has to be a lot of stock buybacks, Alibaba and YJ have to keep increasing in value. But if the core stagnates, and YJ and Alibaba don’t grow at all, I get to a “fair value” year-end 2014 target for Yahoo of $48/share – still 20% above current levels.
In all likelihood, we’ll probably land somewhere in between those two extremes. To me, that suggests Yahoo will probably close 2014 around $60/share — 50% above current levels.
[Eric Jackson was long YHOO and AOL at the time of this post]