Monday, July 21, 2008

Yahoo!: Buyout Valuation Still Pegged @ $33

I've decided to look at Yahoo again. I was first interested in this company when it it broke the $20 level back in January of this year right before the Feb 1st $31 buyout offer by Microsoft.. In late April when Microsoft said they were willing to increase the bid to $33, Yahoo wanted $37 and Microsoft walked away. Then Carl Icahn came in, scooped up a bunch of shares, wanted Microsoft to buy Yahoo at $34.375 or $49.5 billion, and threatened to seek control of Yahoo's board of directors. Also remember that Microsoft bid $40 for Yahoo in January of 2007. In the past month it has hit around $20 and I think it's looking attractive again for a long term turn around or buy out.

It looks like they reported 2nd quarter earnings today and agreed to appoint Icahn and two of his nominees to the board.

Q2 Earnings Summary
Net Revenues: $1.346 Billion +8.2% YoY
Operating Income: $101 Million -45% YoY
EBITDA: $427 Million -10% YoY
Free Cash Flow: $231 Million -30% YoY

From Alleyinsider:

Gross Revenue lower end of the guidance range: $1.78 billion vs. $1.73-$1.93 billion guidance. Net Revenue below consensus: $1.346 billion versus $1.37 billion consensus. Operating Income weak, despite mass firings: Paltry $101 million vs. $135-$155 guidance. EBITDA okay if you exclude $22 million in Microsoft advisory fees: $427 million versus $425-$455 guidance. Even after backing out Microsoft fees, still missed consensus of $450ish. Free cash flow only $231 million, down 30%. Remember when Yahoo used to gush cash? Those were the days. EPS: $0.10 vs. $0.12 consensus. Ouch. Outlook: 2008 Gross Revenue: guidance now $7.35-$7.85 billion vs $7.2-$8 billion previous ("narrowed"), 2008 EBITDA: guidance now $1.825-$1.975 vs. previous guidance of $1.775-$2.025 ("narrowed").

First Two charts from Yahoo Q1 '08 Presentation

EBITDA or Operating Cash Flow Multiple Trend

Obviously a great way to realize value here is through asset liquidation with all of their hidden properties with excellent growth prospects and potential bid premiums.. I'll look at EBITDA or the Operating Cash Flow multiples first. If you were to put on the highest TTM EBITDA multiple of 21 (Q2 '07) during the last 10 quarters, you'd have a $28.50 share price based on this historical comparable. Add to that the future $250-$450 million in incremental operation cash flow that could be generated from the Google Search Advertising Deal, at the minimum $250 additional cash flow, it would fetch $32.30. So Microsoft does have some leverage with the $33 number, however the $450 million of additional cash flow would net a $35.31 value, even higher than what Icahn wants.

In this chart from the March 2008 presentation, Yahoo believes Microsofts bid significantly undervalues the company based on it's: Projection to double OCF growth by 2010 (from $1.9 billion to $3.7 billion), it's market value of asian assets, cash value per share, and it's opportunities in new growth markets.

March 2008 Presentation

From the March 2008 presentation, Yahoo valued it's publicly traded Asian assets (Yahoo Japan,, Gmarket) at $12.6 Billion or about $9 a share. Also, Yahoo owns a 39% private investment of Alibaba Group which owns various entities including TaoBao, Koubei, Alipay as well as an interest in which was already calculated in the allocation previously.

On the most recent conference call, however, Yahoo said it's publicly traded Asian assets were worth $10 Billion or $7, but it did not include the privately held entities owned by Alibaba Group. The decline is most likely related to the big sell off in the Asian markets during the past 3 months.
"Our cash and marketable securities balance was $3.22 billion at the end of the quarter, up over $370 million from the prior quarter. At the end of the quarter, the value of our direct and indirect interests in the publicly traded securities of Yahoo! Japan,, and Gmarket, were valued at approximately $10 billion in the public markets, or over $7 per share. These figures include the value of the shares of held by Alibaba Group, of which we own approximately 40%. These figures do not include estimates of the value of Alibaba Group’s other privately held businesses, such as [Talbow] and Alipay, which we believe provide significant additional value."
This values the Asian assets plus cash at around $9.35/share excluding the additional value from privately held entities of the Alibaba Group. I found various asset valuations during the past 9 months.
"On May 1, 2008, Piper Jaffray issued a research report this morning offering its take on the value of Yahoo!'s (Nasdaq: YHOO) foreign investments. The firm has a Neutral rating and $31 price target on shares of Yahoo!. As Yahoo! has said that Microsoft (Nasdaq: MSFT) is not fairly valuing the company's stock in its attempt to buyout Yahoo!, shareholders are speculating about the worth of several of Yahoo!'s foreign investments, which could turn out to be very beneficial.

Piper calls Yahoo!'s largest foreign investment, Alibaba Group, "one of the best positioned Chinese Internet companies". The firm values Yahoo!'s 39% stake in Alibaba at about $4-$5 per share. Additionally, Piper values Yahoo!'s 33% equity stake in Yahoo! Japan as worth about $6.46 per share, its 10% stake in Gmarket (Nasdaq: GMKT) as worth about $0.08 per share, and finally its 1% ownership in as worth about $0.07 per share. Adding to these investments, Yahoo! had about $4.15 per share in cash at the end of its March quarter. Bringing this all together, Piper sees Yahoo! as holding at least $13.12 per share in foreign investments and cash alone." Source
Other analysts believe it is worth more if their search business was outsourced to google, cutting 25% of their staff and restructuring their main display advertising division.
"On October 5, 2007, Jeffrey Lindsay, analyst at Sanford C. Bernstein, said Yahoo's operations viewed separately could be valued as high as $39 per share, compared with a current share price closer to $27 if it broke up its Internet businesses or embarked on a major overhaul, including a departure from Web search, but management is unlikely to do either, according to an analyst note issued on Friday.

The company, which lags Web search leader Google Inc and faces greater competition for its e-mail services, could be worth as much $45 per share with a dramatic overhaul that would include outsourcing its paid search, cutting staff by 25 percent and restructuring its graphic display advertising, according to Lindsay. Yahoo's main display advertising business appears to have deteriorated, mainly due to the company's troubles in effectively capitalizing on its ad network, Lindsay said. He reiterated a "market perform" rating on the stock, with a $25 price target." Source
With all of this said, it looks like there's a true value range between $30 - $40 based on future cash flow multiples, asset values, as well as Microsoft's public bid of $33. However, especially in this earnings environment, it's hard to pin point an exact realized value using these valuation methods.