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Tuesday, September 21, 2010

Yahoo Addendum: Given the Discount, What's the Problem? Plus, Other Topics

As a follow-up to our Yahoo (YHOO) posts last week, we are relaying a few more musings drawn from reader comments and our responses to our subsequent post on SeekingAlpha.com of "Yahoo: Does Facebook Mean Game Over or Will Hidden Value Prevail?" Content is slightly modified below.

Question (paraphrased): given the incredible discount to the sum-of-the-parts (SOTP) value, why aren't institutional investors jumping all over shares of Yahoo?
  • Our response: Why the disconnect? We think the answer might be this simple: the "Market" likes consistent growth and near-term, positive catalysts (beating expectations), which (honestly) we all like if we're actual or prospective owners of a company. Earnings (and free cash flow) growth is what really drives share prices. See the performance of some of the Chinese Internet leaders, BIDU, SOHU, SNDA and, to a lesser extent, SINA. Or, look outside Internet-land at the long-term performance of companies such as DLB, ESRX, or HANS.
  • Until the Market begins to believe AND see (as seeing is believing for the Market) that Yahoo's management team can and will deliver on growth, margin, and ROIC targets, shares may continue to languish, especially when comScore (SCOR) traffic data implies "user engagement" is moving in the wrong direction. That said, this sum of the parts discount can't last forever and should correct in due course. Also, Yahoo's advanced global advertising platform may enable revenue growth even if publicly available/reported traffic figures are slightly negative (for all properties, no doubt with some up and some down on a channel by channel basis). After all, the display ad market should continue growing nicely for the foreseeable future. Yahoo is a leader in this category.
Comment: per NYTs and numerous other articles, CEO Carol Bartz is on record as saying the Alibaba position is not for sale.
  • Our response: The press has been working overtime on this one and the hubbub happened to correspond with our recent posts (first post re: Yahoo/Google/Facebook on Saturday 9/11)... If possible, amidst reported management tensions, we think it's SMART for Yahoo to HOLD onto the Alibaba position as the latter's value should continue to accrete alongside the growth of Alibaba.com, Alipay, Taubao and other assets.
Question: do you understand the search deal with Microsoft (MSFT)?
  • Our response: There are many facets to the search deal and time will tell how it ultimately works out, both operationally and financially. If we're not mistaken, management's high level perspective is that search is becoming more of a commodity, so why not outsource search and focus more on being a content/media company. Yet, even if search is a "commodity" (debatable), scale matters and partnering with Microsoft brings increased scale for both parties to compete against Google (~65% of the US market per comScore/SCOR). As part of the scale strategy, Yahoo will be buying ads for distribution on both Yahoo Search and Bing. Yahoo included a deck on search at its May Investor Day.
Finally, one additional general comment that we should have included in our earlier post:
  • In our back-of-the-envelope FCF analysis (using summary financials from Yahoo Finance) is that we did not consider any potential tax bills due from possible asset sales nor did we remove interest income from our run-rate FCF estimate (e.g. since we used implied FCF yield on EV rather than MC). BUT, our summary analysis still works for illustrative purposes. Our intention was to highlight the hidden value in Yahoo's various assets and the fact that the core business is essentially being given away. The NYTs piece (via Reuters) does include some mention of taxes with regard to the Alibaba position.
It's possible that renewed awareness of Yahoo's valuable international assets may prove a near-term catalyst despite our mention that the Market may need to see to believe. We'll see.

From a common sense perspective,
shares continue to look like a bargain: established, well-recognized global franchise operating in large, growing markets; strong balance sheet with no debt; large free cash flow; and striking SOTP discount. All offered at approximately 6-7 times current FCF (excluding Yahoo! Japan and the publicly traded Alibaba.com asset).

Happy investing,

Jeffrey Walkenhorst

Disclosure: long YHOO.

© 2010 Jeffrey Walkenhorst
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