Yahoo Investors Can Reap $11 Billion in Breakup: Real M&A

Yahoo! Inc CEO Marissa Mayer
Marissa Mayer, Chief Executive Officer of Yahoo! Inc. Photographer: Simon Dawson/Bloomberg

Yahoo! Inc. shareholders are inching closer to a potential $11 billion windfall.

Activist fund Starboard Value LP stepped up pressure on Yahoo last week to break itself up, a move analysts say could amount to an $11 billion market value gain. Starboard’s proposals include Yahoo selling its valuable stakes in Alibaba Group Holding Ltd. and Yahoo Japan Corp. and merging with advertising rival AOL Inc. The ideas lay out a plan for rewarding investors who are losing confidence in Chief Executive Officer Marissa Mayer’s ability to create value with the acquisitions she’s been making.

Yahoo, now worth less than those Asian stakes, has put $1.3 billion toward takeovers since 2012, around the same time Mayer took the helm, according to Starboard. During that period, earnings before interest, taxes, depreciation and amortization dropped by almost half as revenue also slid. Investors are now left holding a $40.52 stock that could be valued at more than $50 in a breakup -- $51 if you ask Gabelli & Co. and up to $57 by Albert Fried & Co.’s estimates.

“This is a very classic sum-of-the-parts story: If you can break up the company into its different parts, it would be worth a lot more,” Brett Harriss, an analyst for Gabelli, said in a phone interview. “The last thing shareholders want is the management team going out and trying to be venture capitalists.”

Alternatively, Yahoo may be a good acquisition for Alibaba or SoftBank Corp., Harriss said. A deal would enable Alibaba to buy back its shares from Yahoo without a large tax leak. As SoftBank searches for targets, buying Yahoo would increase its stakes in Yahoo Japan and Alibaba.

Sarah Meron, a spokeswoman for Sunnyvale, California-based Yahoo, declined to comment.

Today, Yahoo shares climbed 0.6 percent to $40.75.

Starboard Record

In past investments such as Office Depot Inc. and TriQuint Semiconductor Inc., Starboard’s exhaustive research and activism have helped yield gains for shareholders.

The activist is now targeting a company whose business investors assign no value. Yahoo shares are instead buoyed by the stakes in Alibaba and Yahoo Japan, which add up to more than Yahoo’s closing price yesterday of $40.52. Investors are awaiting the potential payoff from selling those assets, rather than expressing bullishness on Yahoo itself.

With the hype over Alibaba’s initial public offering dying down, bears are beginning to pile in to Yahoo. Short interest is up sixfold from the start of the year to 1.9 percent, the highest since March 2012, four months before Mayer became CEO, according to data compiled by Markit.

“Now that Alibaba’s IPO is in the rearview mirror, Yahoo’s no longer benefiting from Alibaba’s ‘What if’ valuation questions,” Youssef Squali, a New York-based analyst at Cantor Fitzgerald LP, said in a note yesterday. “Marissa Mayer’s honeymoon with investors is over.”

Looking for Cash

While Mayer has focused on making purchases to try to position the Web portal for future growth, shareholders would prefer to see the company’s cash returned to them, said Sameet Sinha, a San Francisco-based analyst at B. Riley & Co.

“You have an activist investor saying ‘You have this cash and we just want to make sure that you will utilize it responsibly, versus the last couple of years where you’ve made a lot of acquisitions that we haven’t seen bear any fruit,’” Sinha said in a phone interview.

Yahoo’s trailing 12-month Ebitda was about $1.8 billion in the period before Mayer took over and embarked upon a takeover spree, according to data compiled by Bloomberg. It has since fallen to $948 million. Revenue declined about 7 percent over that same span.

Tax Savings

Analysts have described many ways Yahoo can reward investors, though most say that a tax-efficient method for exiting the Asian stakes takes priority.

Yahoo retained a 16.3 percent interest in Alibaba after the Chinese e-commerce company’s IPO earlier this month. Selling its remaining shares would create a large tax bill, which could be avoided if Alibaba took over Yahoo, shareholder Ironfire Capital LLC has suggested.

Yahoo is also the second-largest owner of Yahoo Japan behind SoftBank, which means SoftBank could use an acquisition as a way to gain more control of the Japanese business. SoftBank has had internal conversations about buying Yahoo, according to a person familiar with the matter, who asked not to be identified discussing private information.

Mitsuhiro Kurano, a Tokyo-based spokesman for SoftBank, declined to comment. Today, SoftBank’s shares fell 1.7 percent at 11:28 a.m. in Tokyo.

Free Business

The sum of Yahoo’s parts equates to about $51 a share, with about $7.50 from the Yahoo Japan stake, $34 for its interest in Alibaba and $9 a share of cash, according to Gabelli’s Harriss. That means any acquirer would be getting Yahoo’s core business for free.

“Even if Yahoo’s U.S. business went to zero tomorrow, it would still be a fantastic deal for SoftBank or Alibaba,” Harriss said. “And it would be a win for shareholders if they went out and sold themselves.”

Starboard is proposing that AOL, which has reinvented itself as a competitor in the digital-advertising industry, merge with Yahoo to save as much as $1 billion of expenses. Not only would there be cost-cutting opportunities, it may even boost revenue, according to Brian Wieser, a New York-based analyst at Pivotal Research Group LLC.

“Being a larger player means you are in a far better position to get a larger share of your customers’ wallets,” Wieser said in a phone interview. “It also means you have a larger customer base over which to amortize expenses and capital investment that you might not otherwise undertake. For example, investing in higher-quality video content.”

Asset Swap

B. Riley’s Sinha says there’s a way for Yahoo to both merge with AOL and sell its Alibaba stake without the tax penalty: SoftBank could first buy AOL, then exchange it with Yahoo for the Alibaba shares.

He also estimates Yahoo could add about $15 to its stock price by raising money domestically and then giving it to shareholders, rather than paying them with the repatriated proceeds from the Asian assets. Apple Inc. made a similar move last year by borrowing funds to repurchase stock instead of using its overseas cash hoard, which would have been taxed.

The issue for Mayer with keeping Yahoo’s proceeds internationally is that it reduces her flexibility for making further acquisitions, Sinha said.

“Management always wants to do the right thing probably, it’s just that they also have other motivations,” he said. “So it can be good to have an activist there.”

(An earlier version of this story was corrected because it said Yahoo held a stake in SoftBank. Yahoo holds a stake in Yahoo Japan.)

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