Who Will Meet Yahoo at the Altar?

yhooIs there alpha to be gained by virtue of a long position in Yahoo Inc. (NASDAQ:YHOO)?

If so: how is that alpha to be gained? Is the current management on the right track, or does it have to be pushed onto another one? Or consolidated with another locomotive altogether?

These questions are newly prominent for at least three reasons. First, as June began, Yahoo concluded an exclusive deal with the National Football League to livestream the Bills-jaguar game on October 25th. The game will be available for free on any device to any connected user. This may be a game-changer for the development of football as a leisure-time gobbling spectacle. Is it a game-changer for YHOO as well?

Second, the company has an annual meeting coming up. (Well, doesn’t everyone?).

Third, Yahoo’s recent history is the subject of a newly published book from Hachette. Author Nicholas Carlson has written a double biography of the converging lives of Yahoo as a corporation and of its latest CEO, Marissa Mayer. His book ends with two events of last September: the Alibaba IPO and an activist hedge fund’s announcement that it would like to see Yahoo acquired by AOL.   But the book also ends with a hefty dose of pessimism: though Carlson thinks Mayer is “an extraordinary person,” he also strongly suggests she is losing “the fight to save Yahoo.”

Events Too Recent for the Book

There has been a fair amount of water under the bridge since the final events recorded in Carlson’s book. In particular, there was an upward spike in stock price that lasted from mid-October to mid-November. This was driven in part by the rise in the value of the Chinese internet giant Alibaba, in which Yahoo has a significant post-IPO stake, and also in part by a speculative frenzy over that proposed Yahoo/AOL hook-up.

But the appeal of Yahoo as a mere holding company for Alibaba soon faded. Alibaba, after all, is public now. Those who so desire can invest in it directly. Further, the AOL tie-in didn’t go anywhere, so that source of demand, too, faded. The stock, which had gone from a mid-October valley of about $38 to a mid-November peak of $52 headed slowly back down, ending the year at $50.51.

There was some further excitement in January with renewed talk of such an AOL deal, but by the end of that month the bloom was definitively off that rose. Since February, YHOO’s trading range has been roughly from $42 to $46.

So: when it departs from that range, will it do so upward, or down?

On March 9th, Jeffrey Smith of Starboard Value, the aforesaid hedge fund, sent a letter to the CEO and board of Yahoo outlining his present views of the opportunities for creating value for the shareholders. He is no longer pushing for an AOL deal, but he remains full of suggestions.

Full of Suggestions

Smith acknowledged, and praised, Yahoo’s plan to spin off the remainder of its share in Alibaba, and the tax efficiency with which it is acting.

Also on the positive side, Smith acknowledged the growth in Mobile, Video, Native, and Social businesses, which he calls MaVeNS, and which “cannot be separated from the legacy advertising business decline.” He isn’t inclined to give management any credit for the growth in MaVeNS, though. It “would have occurred in substantial part even without large investments by Yahoo,” since throughout the industry users who would formerly have connected to web properties through their PCs are now connecting through mobile devices.

Smith has a three-point plan for Yahoo: cost reductions; the monetization of IP; and the sale of real estate assets.

  • Starboard’s “extensive research has led us to believe that Yahoo can reduce at least $330 and up to %570 million of excess costs (per year).” This will offset an increase in $490 million on operating expense over the last two years.

This can be accomplished through a “rationalization of the expenses for products, content, and initiatives that have little prospect of contributing meaningful revenue in the reasonably near future.” This seems consistent with one of Carlson’s themes. Separately,

  • Yahoo’s IP portfolio includes patents for email, web, search, and advertising. Through a ”robust licensing effort” with this portfolio Yahoo could realize “at least $600 to $700 million of value from these assets (net of tax) and potentially more as the existing licensing deals expire.”

On a related front, Smith objects to the way Yahoo’s accounting treats the IP monetization in which it does presently engage. It records the receipts from patent licensing as “cost benefits” so that on the income sheet they reduce expenses rather than increasing income. This feeds back into the previous point. The accounting for IP is making the operating expenses seem lower than they are, making it appear that cost cutting is less urgent than it is. Finally,

  • The real estate portfolio is also extremely valuable. Sale-leasebacks could monetize this without “a direct impact on the operations of the Core business,” since Yahoo could remain the sole tenant of the properties involved.

Cash and a Conclusion

Smith is also unhappy that Yahoo is holding so much cash. Yes, the company has repurchased $3 billion in stock since the Alibaba IPO, but there is still “no reason for Yahoo to continue to hold over $5 billion in net cash.”

In essence, he is saying, “If you hang on to that much cash, you’re just going to go and buy some expensive unhelpful bauble with it.” The baubles are acquisitions such as Brightroll (an online video advertiser Yahoo bought in November) or Cooliris (photo viewing, also November).

Smith’s proposals are interesting, but it isn’t clear several months after he first entered the picture that he has any pull.

My own suspicion is that in the not-too-distant future YHOO will be acquired by somebody. It is a tempting target precisely for the reasons specified in Smith’s discussion: that real estate, those patents. Also, the brand name is a familiar one, and web-based email remains far from dead in middle America, obsolete though it may seem to some cognoscenti. Somebody will buy YHOO, and there is alpha to be found for those who figure out the timing before it’s in all the headlines.

 

 

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