Yahoo Spinoff Shock Lingering in Options Market on IRS Concern

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While Yahoo! Inc.’s stock has climbed back from last month’s spinoff scare, options trading shows the issue is still on investors’ minds.

Bearish Yahoo contracts are about the most expensive relative to bullish ones in nearly two years, data compiled by Bloomberg show. The gap, a sign traders are buying insurance against a falling stock, has remained wide even after the shares erased most of a 7.6 percent plunge from May 19. That drop was triggered by new tax scrutiny for spinoffs at a time Yahoo is planning to create a separate company for its Alibaba Group Holding Ltd. stake.

“There’s uncertainty because of the IRS rule change that might be coming into effect under certain circumstances,” said Brian Wieser, an analyst at Pivotal Research Group who has a hold rating on the shares and a price target of $49. “You wouldn’t think the IRS would want to apply rules retroactively to something that’s been announced, but on the other hand, it hasn’t been completed.”

Options protecting against a 10 percent decline in Yahoo shares cost 1.6 points more than those wagering on a 10 percent rise, three-month data compiled by Bloomberg show. The relationship known as skew touched the highest level since July 2013 on May 21.

Yahoo slid 0.5 percent to $43.15 at 4 p.m. in New York.

Rules Change

Shares of the Web-portal company have recovered about three-quarters of the $3.38 plunge on May 19, which came after an Internal Revenue Service official said the agency is “thinking about” changes in how it treats spinoffs involving businesses that are small compared with a company’s other assets. The agency will hold off on such requests for new rulings going forward as the issue is studied, but requests for rulings that are already in the pipeline will move forward, though that is subject to change, too, he said.

A change in the rules behind these transactions could hinder Yahoo’s plan to shed its shares in Alibaba. A U.S. company would typically face a federal tax bill of about 35 percent when it sells stock in another company for cash.

Yahoo is structuring its deal as a complex spinoff, putting its Alibaba stake into a new company that will also own an online service for setting up and running small enterprises. Shares in the new company would then be distributed to existing Yahoo shareholders, which the company hopes will ensure tax-free treatment for the deal.

“Yahoo’s plan for a tax-free spinoff of its almost $40 billion stake in Alibaba to shareholders by the fourth quarter may come under threat if the IRS retroactively examines the company’s request,” Bloomberg Intelligence analysts Paul Sweeney and Praveen Menon wrote in a note May 20.

Expected Windfall

Evercore ISI analyst Ken Sena lowered his rating on Yahoo to hold and cut his target price to $48, saying the IRS’s heightened scrutiny could create delays and confusion for companies undertaking these deals, similar to government actions taken against tax inversions.

Rebecca Neufeld, a spokeswoman for Yahoo, declined to comment on the options trading.

Yahoo speculators have been expecting a cash windfall from the spinoff since Alibaba announced it would go public in March 2014. The cost of three-month bullish options rose to a record high versus bearish ones in August. Shares of Yahoo climbed as much as 28 percent in the two months following Alibaba’s debut.

The value of Yahoo’s stock with the Alibaba and Yahoo Japan Corp. stakes and cash factored in is about $52, according to Brett Harriss at Gabelli & Co., 20 percent above its closing price Monday. While an increase in the tax rate on the spinoff would cut this value, the deal won’t be affected by the IRS rules, he said.

“This transaction has been done so many times that it’s likely going to be legal,” said Harriss, an analyst for Gabelli in Rye, New York. He has a buy rating on Yahoo shares. “I don’t think they’ll have to pay corporate-level taxes.”

Short interest in Yahoo has dropped to the lowest in more than a year. About 3.1 million Yahoo shares, or 0.3 percent of shares outstanding, were sold short as of Friday, the fewest since April 2014, data compiled by Markit Ltd. show.

Skew “is near its steepest level of the year,” said Alex Kosoglyadov, vice president of equity derivatives at BMO Capital Markets Corp. in New York. “The option market is pricing in elevated downside risk on the back of potentially increased scrutiny of tax-free spinoffs.”

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