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Friday, 24 October 2014

Buyback is the Wrong Strategy for Yahoo!

During Yahoo!'s Q3 earnings call, we have seen both its CEO and CFO continuing to emphasize that buying back shares of Yahoo! is the right strategy to return capital to shareholders over the long-term.

However, in my view, this is a risky strategy pursued by the company in returning capital to its shareholders. As such, I am more on the side of pushing for Starboard's activist action in Yahoo!.

I laid below some mathematical calculation why Yahoo!'s buyback is a bad strategy:

Yahoo! retains 384 million shares of Alibaba, I value each share at $90, representing $34.56 billion pre-tax and $22.46 billion post-tax of value.

Yahoo! retains 35% of Yahoo! Japan that is valued at close to $7.8 billion pre-tax and $5 billion post-tax.

Yahoo! has cash of $12 billion as of end of Q3, with $3.3 billion of tax liabilities due 2015. Net cash position is $8.7 billion

Yahoo! also has a long-term liability (excluding taxes) of near $1.3 billion.

Net asset value of the company pre-tax is $53.2 billion and post-tax of $35.1 billion.

Share buybacks are only effective when shares are bought when they are undervalued and when the core business is a good business.

Assuming Yahoo! has 1 billion shares outstanding (for easier tabulation).
Yahoo! is a sum-of-parts investment, where its share price is currently the value of its assets - Pre-tax of $53 billion or Post-tax of $35 billion.

Conservatively, assuming that Yahoo!'s total net assets are worth $35 billion, and it spent $1 billion on buybacks. Its new asset value will be $34 billion. With 1 billion shares outstanding, each share price will fall from $35 to $34, unless Yahoo! is able to purchase 2.85% of shares outstanding (1/35) with its $1 billion cash buyback, which would maintain the value of Yahoo! shares at $35.

Unless Yahoo! is able to buyback shares below their net asset value or potential net asset value, its share buyback program is a bad allocation of capital. If Yahoo! over pays for shares during its buyback, it will be destroying shareholder value instead of creating them.

In addition, buyback is only worth when the core business is good. However, Yahoo! is still a company that requires turnaround. The management may be positive about the future of Yahoo!, but they are suppose to, even if deep down they are not positive. Because turnaround carries risk that it may fail, it is better to return capital to shareholders than to perform share buyback.

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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