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Tuesday, 28 October 2014

6 Things Yahoo! needs to do

Yahoo! has rose by almost 15% from its bottom of $37.82 on 15 Oct 2014. In its Q3 earnings, management has said that it will continue to invest in its mobile growth strategy and buybacks. Although this is good news, especially we do see growth in mobile materializing, the capital structure of the company in my view still have room for improvements.

1) The optimal size for Yahoo! is $10 billion or less currently in market cap. With $480 million in 2013 operation income, Yahoo! should be worth between a range of 10x - 20x P/E, valuing its core at $4.8 - $9.6 billion. Yahoo! should not own more cash than what its earnings are fundamentally worth.

2) A company worth $5 billion in market cap based on core operating income should not be given management of more than $35 billion in cash & near cash assets. Excess money should be return to shareholders to ensure management does not make bad decisions because it has a huge cash pile. It is also technically tough for management to utilize the cash and grow the core business to be worth at least 7 times its original size.

3) Yahoo! can continue to act as both an operating company and as a VC company, but it has to return most of its VC investment return more efficiently to shareholders while continuing to grow its core operating business.

4) While buybacks are good for the company's long-term shareholders, Yahoo!'s buyback reduces asset per share of the company, which reduce its price per share because Yahoo! is valued by its asset.

Yahoo! currently has a market capitalization of $43 billion, roughly $8 billion above its post-tax value of $35 billion, meaning that investors believe that management might be able to help save $8 billion of tax expense from its sale of its Asia assets (or its core is worth some money).

With $12billion in cash, if Yahoo! spends it to buyback it shares when its market cap is $40 billion, it would be able to purchase back 30% of its shares. Subsequently, it will have a net asset value of $23 billion + $5 billion value in its core business. The $8 billion in tax savings would put Yahoo!'s market cap at $35 billion, and with 700million shares outstanding, each share will be worth $50.

However, if Yahoo! perform a buyback when market cap is at $40 billion, it will only be able to buy back 26.7% of its shares, leaving a 733million shares outstanding. At $35 billion market cap, each share will be worth $47.75. A difference of $2.25 per share, which at current $43 price accounts to nearly 5% difference in potential returns.

I am not saying Yahoo! is overpriced. I am only saying that it is overvalued for a buyback, but it is reasonably priced.

5) 1% ownership of a failing business and 10% ownership of a failing business doesn't make a difference, the business is still failing. Yahoo! is undergoing a restructuring period and while the management may be doing a great job trying to turn around the company, it is still a 50-50 bet. With reference to point 2, the safer bet for Yahoo! would be to return the capital to shareholders so that we don't own what could be a fail turnaround. IBM is a great example of a most recent buyback failure.

6) They failed to maximise the tax benefits for shareholders in the previous 2 sell-off of Alibaba shares (one during 2012 and one during Alibaba IPO). Management failed in 2 times in situations where shareholder value could be protected, thus it is not very clear if the same management team would be able to effectively protect shareholders from the huge tax bill from Yahoo!'s Alibaba sale.

I am a shareholder of Yahoo!, I am writing this article to show my view regarding Yahoo!'s capital return program. I am also not receiving compensation from the above company or any other company. Above are just my 2 cents view of the company's valuation and are by no means any form of recommendation to purchase the stock.
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