Yahoo CEO Mayer in Familiar Hot Seat Amid Starboard Push

The pressure on Yahoo! Inc. Chief Executive Officer Marissa Mayer has just ramped up.

Activist investor Starboard Value LP yesterday sent a letter to Mayer urging her to consider strategic alternatives to “unlock value” at the Web portal, including a combination with AOL Inc. Starboard CEO Jeffrey Smith also recommended to Mayer that she cut costs and stop making new acquisitions that she has been undertaking to boost the Sunnyvale, California-based company’s growth.

The letter’s timing was no surprise. Starboard sent its missive a little more than a week after Yahoo sold about a quarter of its stake in Alibaba Group Holding Ltd. during the Chinese e-commerce company’s initial public offering. The divestiture was a key step in reducing ties with Alibaba, which had helped buoy Yahoo’s stock.

Since Alibaba’s IPO, the true value of Yahoo’s core business has been laid bare -- and its worth has been shown to be minimal. Mayer, who arrived at Yahoo in 2012, has so far been unable to rev up the company’s growth as it faces pressure from rivals such as Google Inc. and Facebook Inc. She also hasn’t clearly laid out what she intends to do with the money she’s receiving from the Alibaba stake, or how she’ll avoid taxes when she sells off more shares.

“The reality is that the core business has not turned around,” said Ben Schachter, an analyst at Macquarie Securities USA Inc.

Closing Gaps

The issues have frustrated investors, who have kept Yahoo’s shares little changed this year. The stock, which closed yesterday at $40.66, is up less than 1 percent this year, compared with a 7.2 percent gain in the Standard & Poor’s 500 Index.

“Clearly Yahoo is deeply undervalued relative to the sum of its parts,” Smith wrote, adding that the fund now has a “significant” stake in Yahoo without disclosing specifics. “It is incumbent upon management and the board to take immediate steps in committing to remedy this valuation discrepancy.”

Mayer later responded that Yahoo is committed to “acting in the best interests of the company and all of its shareholders.” She said Yahoo will review Starboard’s letter and looks forward to discussing the matter.

“We will continue to focus on evaluating various capital allocation initiatives, an update to which we plan to provide on our third-quarter earnings call,” Mayer said in a statement yesterday.

Eoin Ryan, an AOL spokesman, wasn’t available for comment. Starboard representatives didn’t respond to requests for additional comment.

Mayer’s Turnaround

Yahoo shares jumped 4.4 percent at the close in New York after Starboard released the letter, while AOL climbed 3.7 percent to $44.55.

AOL would be a good fit for Yahoo, according to Colin Gillis, an analyst at BGC Partners. The Web portal would bolster Yahoo’s video and editorial content and is a better option than buying a “high-priced startup,” he said.

“It makes tremendous sense,” Gillis said. “It will move the needle materially on both revenue and earnings.”

Alibaba’s IPO, the largest on record, provided a windfall of more than $9 billion for Yahoo before taxes. The company has said it will return at least half of that to shareholders.

As investors took gains on Yahoo after Alibaba’s IPO, the Web portal’s core online-advertising business was valued at less than that of its Asian assets, which also includes a stake in Yahoo Japan. Yahoo’s market capitalization is $40.4 billion, while AOL’s market value is $3.5 billion.

Mayer Tries

Mayer has tried to shore up Yahoo’s business by acquiring startups and investing in content and services to woo more Internet users and attract advertisers.

So far, her efforts have failed to narrow the company’s widening gap in online advertising with Google and Facebook. Second-quarter sales, excluding revenue shared with partner websites, fell to a less-than-projected $1.04 billion. Analysts on average estimate revenue this year will slip to $4.35 billion, the lowest level since 2005, according to data compiled by Bloomberg.

This isn’t Yahoo’s first encounter with an activist investor. Daniel Loeb’s Third Point LLC targeted Yahoo in 2011, when the fund bought a 5.2 percent stake and urged the board to resign. Loeb forced the ouster of former Yahoo CEO Scott Thompson and took a seat on the board. Loeb later sold the stake back to the company.

Starboard’s Recommendations

In Starboard’s letter, Smith said Yahoo’s Asian assets are worth about $11 billion, or “$11 per share more than the current enterprise value of the company.” That is the gap that needs to be closed, he said. Enterprise value, a metric to gauge the takeover value of a company, includes market capitalization and debt, minus cash and equivalents.

Yahoo should also pull back on its acquisitions, which have already resulted in $1.3 billion of spending since the second quarter of 2012, Smith said. That includes the roughly $1 billion purchase of blogging-service Tumblr last year.

“Focusing on acquisitions has not worked,” Smith wrote. A combination with AOL would create “synergies,” he added.

In addition to acquisitions, investors are concerned Yahoo will monetize its stake in Alibaba without finding ways to escape big tax hits that can reduce proceeds by 38 percent, he said. Yahoo hasn’t done enough to show how it will be more efficient with taxes, he said.

“We believe management should immediately and clearly articulate how it intends to deliver value from these investments to Yahoo shareholders in the most tax-efficient and expeditious manner,” he said.

Starboard Strategy

Founded in March 2011, Starboard typically focuses on a small-cap activist strategy developed by Smith and Mark Mitchell since 2002 and Peter Feld since 2005 -- buying stakes in companies they call undervalued and pushing executives and directors for changes such as unit spinoffs and asset sales.

Starboard recently targeted Darden Restaurants Inc., the owner of the Olive Garden chain, Aaron’s Inc., a furnishing and appliance supplier, and Emulex Corp., which sells chips that help computer servers and storage networks transfer data.

Starboard knows AOL after previously pushing for change at the New York-based Internet company. The fund went public with its AOL stake in December 2011, building up ownership of more than 5 percent. AOL fended off that challenge, which included a call to shake up the board. Starboard exited its AOL stake by late 2012.

AOL CEO Tim Armstrong and Mayer were former colleagues at their previous employer, Google.

Activist investors tend to buy at least 5 percent of a company’s stock and flag their intention to actively engage corporate executives and directors by disclosing their holding in a 13D filing with the U.S. Securities and Exchange Commission.

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