Shares offer good intrinsic value upside at current levels

Yahoo picks up steam in mobile advertising, MaVeNS should boost profits

Unfavorable IRS tax ruling on Alibaba spinoff could hurt shares and make them even more attractive

Yahoo Inc. (NASDAQ: YHOO), well known for its portal, search and display advertising and online solutions for automobile purchases, e-mail, games, general and sports news, employment, stock market and weather, is a company in transition as it morphs to compete against deeper-pocketed online behemoths and a spate of highly-valued startups. Over the past few years, under new CEO Marissa Mayer, the company has been on an acquisition spree – rushing to acquire companies before rivals snap them up, often paying eye-popping premiums to stay competitive and address gaps in its own offerings. For example, the company acquired online photo management solution Flickr and online short-form social networking solution Tumblr. As of April 2015, Yahoo had 151.3 million unique visitors and controlled 13% of the desktop search market.

Yahoo’s CEO has been under pressure to deliver stronger results and company shares have been under pressure relative to peers. But, of late, Yahoo has struck impressive deals with the NFL and favorable partnerships with Microsoft (MSFT) and others. In addition, Yahoo plans to divest its stake in Alibaba to shareholders. While the spinoff is expected to be tax-free, Yahoo is still waiting for IRS approval, which Yahoo believes it will get. However, uncertainty over the $10 billion tax-bill on the spinoff has played on Yahoo’s share price, making this an ideal opportunity to increase positions on a company that appears to be finally believing in itself.

Moreover, as of 6/19/2015, Yahoo had a market capitalization of $38.02 billion which barely values the company equal to its roughly $40 billion stake in Alibaba and ignores Yahoo’s robust core business and its 35% stake in Yahoo Japan that’s worth close to $9 billion. So shares are a steal at current levels. And as Yahoo followers noted, the company generated some excitement over its gains in the mobile ad sector which now has an annual revenue run rate of over $1 billion.

Yahoo to Spinoff Stake in Alibaba Group to Yahoo Shareholders

At a recent conference, Yahoo reaffirmed plans to spinoff of its 15% stake in Chinese e-commerce company, Alibaba (BABA). When the spinoff was announced in January 2015, Yahoo’s Alibaba stake was valued at approximately $40 billion. In the spinoff, Yahoo shareholders will receive shares in Alibaba through a tax-free transaction despite announced changes in IRS rules that would not be retroactive and affect previously filed requests. Analysts peg Yahoo shares, as a sum-of-the-parts analysis, to be worth $40 per share without the tax shield and $52 per share with a tax shield. Management expects to complete the spinoff during Q4 2015.

Alibaba Group (BABA) – China’s Leading E-Commerce Company

Alibaba Group, the Chinese online and mobile commerce company, operates specialized international marketplaces through its global subsidiaries. The company also offers advertising and marketing solutions, cloud storage solutions and payment solutions for consumers and businesses. Alibaba recently announced that COO Daniel Zhang will become CEO as the company shifts its leadership to a ‘younger generation’. The company is also replacing its CTO, CRO, CSO and CMO with individuals born after 1970. Alibaba most recently reported earnings that beat analyst estimates.


Spinoff Positive: Yahoo Can Focus on Core Businesses after Spinoff

The spinoff of Yahoo’s stake in Alibaba has brought significant value to shareholders, with Yahoo’s initial $1 billion investment in 2005 now up 40-fold to $40 billion. After the spinoff, Yahoo will focus on growing its core businesses through innovation, new partnerships and acquisitions. The low target price on Yahoo shares is pegged at about $48 which represents 18% upside potential over current levels. Yahoo plans to focus on mobile, video, native and social (MaVeNS) businesses to compensate for any dips in its core units, and expects MaVeNS to contribute over $1.5 billion to revenue in FY2015 with growth of about 36%.


Risks: Yahoo’s Core Businesses Have Not Been Performing Well Of Late

After the Alibaba spinoff, Yahoo will only be valued for its core assets. Over the last year, the company’s monthly share of searches across desktops, tablets and mobile devices has stayed almost flat – which is not a good sign. In addition, management’s low-end guidance for Q2 2015 revenue hints at a 2% drop in revenue.


Additionally, if the IRS rules that the spinoff is not tax-free, Yahoo could take a $10 billion hit, or $11 per share, which is about 25% of the company’s share price as of market close on 6/19/2015. Moreover, from a timing perspective, some shareholders believe Yahoo dragged its feet on the sale and missed the peak as Alibaba shares are down about 8% since they began trading and down about 17% year-to-date.

In addition, reports suggest that Yahoo’s Board isn’t happy with the high prices paid for past acquisitions, such as Tumblr, which have failed to deliver on expected market share gains. As a result, Yahoo’s CEO is under pressure and could well be sacked if market share and innovation lag peers.

All of these factors have been plaguing shares, which appear to be undervalued and offer reasonable long-term upside.

Yahoo Shares Down 20% Year-To-Date but Bullish Analysts See 67% Upside

Yahoo shares closed at $40.51 on 6/19/2015, giving the company a market capitalization of $38.02 billion. Shares are close to the middle of the company’s 52-week range of $32.93 – $52.62 and are down 20% year-to-date. Shares are below the company’s 50-day moving average of $42.81 and 200-day moving average of $45.35. With earnings of $7.32 per share, Yahoo has a price-to-earnings ratio of just 5.7x and a price-to-book ratio of just 1.1x – making shares a fairly compelling buy because Yahoo has a strong franchise with a solid base of daily repeat customers.


Tigress Financial downgraded Yahoo to a Neutral rating while Evercore Partners downgraded the company to a Hold rating with a price target of $48 per share (18% upside). Raymond James maintained an Outperform rating on Yahoo and lowered its price target from $55 to $48 per share. Yahoo has an average consensus price target of $54.09 (33% upside) and high price target of $68 (67% upside).

Yahoo management approved a $2 billion addition to the company’s $5 billion share repurchase program from 2013. The original share repurchase program expires in December 2016 while the extension expires in March 2018.

Yahoo does not pay dividends.

Yahoo and Microsoft Partnership Beneficial to Both, Favors Yahoo

Yahoo renegotiated its 10-year search-and-advertising agreement with Microsoft (MSFT), and included a termination clause that allows either company to amend or terminate the partnership after February 23, 2020. Additionally, Yahoo is no longer required to use Microsoft’s Bing search engine for all desktop-search generated advertisements. Yahoo will also receive a share of revenue from Bing ads generated through searches on Yahoo.


Yahoo also has a partnership with Mozilla and its Firefox browser. In the company’s latest earnings release, management noted that Mozilla helped drive revenue growth and grew searches to a new five-year high.

But beyond search volume growth, Yahoo needs to address the critical issue of growing revenues tied to search as advertising dollars shift to platforms such as Facebook and Twitter that offer younger audiences and more impulsive, peer-influenced purchases.

Yahoo Streamlines Operations with Focus on Live, Digital and Original Content

As part of management’s plan to streamline operations, Yahoo will close its maps division, its music pages in Canada and France, movies in Spain and autos in the United Kingdom. Yahoo will instead focus on search, communication tools and content, and announced plans to launch 18 new series across its live digital magazines and original content platforms.

Yahoo also announced a digital media partnership with the National Football League (NFL) for the first, globally streamed live NFL game ever! On October 25, 2015, Yahoo will live-stream an NFL game featuring the Buffalo Bills and Jacksonville Jaguars. The NFL hopes that live-streaming games over various computing platforms will increase viewership, popularity and profits over the long-run as younger viewers switch from television to mobile and Internet-connected devices.


Yahoo also expanded its partnership with ABC Entertainment and will stream original ABC programming in addition to ABC News which it already streams.

Recent Product Updates Attract Users, Increase Advertisement Revenue

Yahoo has partnered with Interactive Advertising Bureau (IAB) and Media Rating Council (MRC) to offer independent viewability and fraud measurement for advertising on the company’s owned and operated properties. This gives advertisers greater understanding of advertisement effectiveness to improve performance and returns. Advertisers will also benefit from the integration of Flurry Personas in Yahoo Gemini which aims advertisements to users based on their mobile application activity.

To help developers understand user behaviors, Yahoo Mobile Developer Suite will include analytics for Apple’s (AAPL) Watch lineup and other platforms, and are integral in measuring the behavior and interactions people have while using various applications.

Yahoo’s Flickr unit updated its tools to offer easier storage, picture organization and search. Pictures can now be labeled by category to simplify navigation in response to user feedback. Flickr’s users rose about 15% from March 2014 to March 2015 and the application now has 11.5 million photo updates daily.

Management team experienced in developing a global leader

In July 2012, Marissa Mayer was named Chief Executive Officer, President and Director. Earlier, Mayer worked for Google (GOOG) for 13 years and oversaw the development of local and geographical products. Yahoo’s Board reportedly isn’t happy with Mayer’s performance and has her on a performance timeline.

Ken Goldman became Chief Financial Officer in October 2012 and is responsible for the company’s global finance functions. Goldman previously held the same role at Fortinet Inc. (FTNT), Dextarra Inc. and Siebel Systems Inc. He has over 15 years of senior financial experience.

Jackie Reses is Chief Development Officer and directs the company’s global development strategy. Before joining the company, Reses worked at Apax Partners, iBuilding Inc. and Goldman Sachs (GS). She also serves on Alibaba’s Board.

Q1 Revenue Grows 8% to $1.23 billion as Search and Display Revenue Increase

For the three months ended March 31, 2015, Yahoo had revenues of $1.23 billion (up 8%) as search revenue increased 20% while display revenue increased 2%. The increases were slightly offset by a 2% drop in other revenues. Yahoo reported a loss from operations of $87.4 million (down from an operating profit of $30.2 million in the year ago quarter) on higher cost of revenue and product development expenses. The company reported net income of $21.2 million ($0.02 per share), down 93% from $311.6 million. Positive net income was driven by earnings from equity interests, not Yahoo’s core business, and this concerns analysts.


As of March 31, 2015, Yahoo had $1.19 billion in cash and cash equivalents, $18.65 billion in long-term debt and $38.79 billion in total shareholders’ equity.

Management released second quarter 2015 guidance of $1.21-$1.25 billion in revenue, $240-$260 million in adjusted EBITDA and $90-$110 million in non-GAAP operating income.

Summary

Yahoo is a solid franchise with a loyal user base, strong partnerships, meaningful product development and a strategic focus on divesting non-performing web properties. Shares currently trade 1-to-1 as Yahoo’s stake in Alibaba but ignore Yahoo Japan and the company’s core business. But Yahoo is under pressure from nimbler, more innovative and deeper-pocketed rivals such as Google (GOOG), Facebook (FB), Twitter (TWTR), SnapChat and others. The company has been plagued by management upheaval and costly missteps, and shares trade at 1.1x book value and less than 6x earnings – and offer compelling upside at current levels.

Shares could come under pressure in the coming weeks if the IRS rules against favorable tax treatment on the spinoff of Yahoo’s Alibaba stake. Moreover, many are skeptical of Yahoo’s standalone prospects after the spinoff – so shares may lose favor and offer an even more compelling entry point in the coming weeks.

 

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