The undervaluation of Yahoo’s asian cross holdings should not last much longer because the deal to sell Verizon the US Yahoo Core should close in 1Q17 and the new republican administration is widely expected to cut the corporate tax rate to 15%. In 2Q17, Yahoo appears likely to sell its Yahoo Japan shares, merge away or liquidate its Alibaba stock and distribute remaining cash.
Today’s $38.50 closing price represents a 30% discount to the $54.83 sum of the parts, or a $16.33/share spread. If we taxed/discounted the entire structure at 15% we get $54.83 * (1-15%) = $46.61, or 20% upside from $38.50.
Yahoo has its core business ($5.07/shr), a pile of Alibaba [Ticker: BABA] stock ($34.89/shr), a heap of Yahoo Japan [Ticker: 4689 JP] ($8.07/shr) and a giant stack of net cash ($6.80/shr): $5.07 Core + $34.89 BABA + $8.07 4689 JP + $6.80 Cash = $54.83 total. Verizon will pay about $730mm in cash to close out Yahoo’s 21mm share equity incentive plans, so the the per share estimates above benefit modestly.
The downside? If we put both the Alibaba and Yahoo Japan stakes on 40% discounts, respectively, cash on a 10% discount and fix Yahoo Core at the take-out price, the downside is about $37.00 or -4% from $38.50. Another way to think about the downside in Yahoo is to reflect on the downside in BABA. We don’t have a view on the BABA downside because we hedge it out. That said, for the fiscal year ended March 2017E, BABA is expected by the Street to earn $3.16/share (+81% y/y) on $21.7bn of sales (+14% y/y).
Long 1 Yahoo share and short 0.4 shares of BABA (the so called ‘yahoo stub trade’) has had fits and starts - see below. This chart does not hedge out Yahoo Japan. Key drivers have been IRS announcements and company comments. Many investors have owned the stub on swap, a higher return, capital efficient (albeit more volatile) approach that appears poised to finally work.
Some have argued that the Yahoo remainco will be acquired in an all stock deal by the Alibaba mothership. Reasonable people may differ as to the likelihood of a deal but we can all agree that given the choice, Alibaba would prefer not to have a $30bn liquid alternative to its own stock floating around forever, particularly when that alternative persistently trades at some discount and represents 15% of their own company. If the tax rate stays 40%, bears may argue that Alibaba will bide its time, talk down the chance of a deal and then make a lowball offer. If the tax rate changes to 15%, bulls would argue that BABA will wait until Verizon has cleared away the US Yahoo Core and then take a clean shot at an all stock offer at some small discount to parity. The board’s task is to move the conversation away from tax discount and toward merger premium by creating a competitive bidding process. The fairness standards of the Delaware courts support the bull case.
Verizon expects to close the purchase of the Yahoo US core operation during 1Q17, and this week received approval from European regulators. Also in the news this month, Yahoo disclosed a billion user data breach that was thought to have taken place in 2013. The breach news represents the second such case following the announcement of the transaction. NY Times DealProfessor seems to think no one cares about the data breach (or for that matter any of the other recent data breaches by other companies)
In response, Verizon may seek a price cut. But based on our conversations with Verizon, they still like the asset, and while they may or may not get it cheaper, and they are still doing the deal. Let Yahoo cut the price by a billion dollars, or let them not cut the price by a billion dollars. Yahoo has roughly a billion yahoo shares outstanding. Cut the price of the Yahoo core and one cuts the proceeds paid to Yahoo by about a buck a share. Yahoo closed at $38.50 yesterday, so a $1 change in price is a 2.6% change in value. Yahoo sneezes and its share price moves 2.6% in a day.
With limited downside, a hard catalyst and favorable tax and fiscal policy - at long last the Yahoo trade appears ripe (whether stub trade or outright long).
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
1Q17 close of Verizon's cash purchase of the Yahoo US Core