Leucadia National Annual Meeting 2013

So I did make it to the Leucadia National (LUK) annual meeting this year.  As usual, these aren't comprehensive notes or anything like that. These are just some loose notes on certain things.   I didn't take detailed notes so some things might be a little off here and there, but I don't think I am off in the general ideas that were talked about.

First of all, both Steinberg and Cumming were there but since Cumming is no longer chairman, he sat in the audience and Steinberg made some introductory remarks and did the usual annual meeting stuff and then Richard Handler took over and ran the rest of the meeting.

This may be a first, but LUK had a slide show for this meeting.  You can see it here.  (Of course I did wonder for a second if Berkshire Hathaway will have a slide show in the post-Buffett era.)

Here is the first slide:

For the Berkheads that need to know, Berkshire Hathaway returned +15.7%/year from 1990 through 2012. But the JEF figures exclude dividends and the LUK figures exclude the special dividend back in 1999 (the HomeFed spinoff is also not included).

The meeting didn't seem as crowded as last year, but I can't say for sure.  The whole vibe of the meeting was a little different as it wasn't a Cumming and Steinberg show.

Anyway, Richard Handler did a really good job, I think, and people should feel comfortable that LUK is in good hands (even though it is now a very different entity so I totally understand people getting out now).  He talked a lot about the things he thinks are really important; act like owners, emphasis on risk management, diversification; avoid all-in bets, importance of balance sheet strength, capital structure etc.  He did say that protecting bondholders through the cycle is important for shareholders.

He said that what LUK has now is really good and he is excited about it; strong balance sheet / capital, good businesses.  This will be the basis of a lot of opportunity to create value over the next 5, 10, 15 years.

Culture
The culture at Jeffries (and LUK) is about honesty, high integrity, long-term greedy, acting like owners, non-bureaucratic, no arrogance (he said arrogance was the downfall of many companies), stay humble, do good things in good times and you'll get through the bad times.  He said that one thing he learned from Cumming / Steinberg is that even with their tremendous track record of success, they stayed humble and never got arrogant.   When you get arrogant, you start to think bad things can't happen to you.

Sees great opportunity in the investment bank / merchant banking model.  I forgot what this comment had to do with anything, but Handler said that Cumming and Steinberg rarely agreed on anything, but when they did things turned out really great.

Complicated Company
Handler said that LUK is a complicated company with a lot of moving parts but what they will focus on is how to build book value per share (BPS) over time.  He thinks they will create a lot of value.

President Brian Friedman briefly went through the various business lines mostly just saying that he sees upside in all of the areas and feels good about them.  The exception seemed to be Sangart where he said we will have to see how it develops.  Not in the list above is the Oregon LNG project which Friedman says has a lot of potential, but also a lot of work to do to get it realized (regulatory issues etc.).

He said LUK will focus on opportunities not available to the public, not run-of-the-mill things.

In early July, LUK bought Topwater Capital, a fund of funds business.  It's small, but there is a lot of potential to build it up over time.

National Beef
Founding partner and current CEO of National Beef, Tim Klein, also made a quick presentation of his business.

The key points are that National Beef is focused on going up the value chain to improve margins.  They are also processing / selling hide to improve margins.   U.S. is now a beef exporter and demand is expected to increase over time globally (increasing demand for protein).

They bought the rest of Kansas City Steaks as part of their plan to go up the value chain.  I think he said that Omaha Steaks does $400 million in revenues and Kansas City Steaks does only $20 million so there is a lot of potential.   There was no mention of (nor were there questions) any sort of discount to LUK shareholders. Klein said that the problem with lower cattle supplies due to the drought is ending as ranchers are starting to build up their herds again, but it may be two or three years before we start to see that coming back into the supply chain (I assume that means that it will take that long to see increasing volumes and improving margins).

Berkadia
LUK initially invested $217 million in Berkadia and as of July 2013 $191 million has already been paid out, and there is still "substantial value" going forward.

There is tremendous upside if interest rates go up, especially short term interest rates.

Scale matters in this business, so there is a lot of consolidation potential to come.

Garcadia
Garcadia is another roll-up type business where the industry is really fragmented.

Jefferies
Jefferies has been listed for a long time so I think many people are well aware of their business.  It has grown a bunch into a full service, global investment bank since 1990 when they were primarily a cash equities business with 140 employees and $7 million in net income. Handler mentioned a number of times that they don't engage in proprietary trading and are very client focused.

My comment:  Their ROE over the years is not as good as some of the majors, but that is probably due to JEF's not getting involved with proprietary trading, derivatives, internal hedge funds etc.  So it's possible that they are not as impacted going forward by many of these new regulations.  So on that basis, JEF can be interesting to people who do worry about that sort of thing at GS, JPM etc...  But that's just a thought.

OK, so these were some of the slides and comments from the various businesses where the CEOs were present.

Q&A
Here are some Q&A's, not word for word or anything like that

Rogue Traders
Someone mentioned that LUK shareholders never had to worry about rogue traders, but now with JEF, they do.  How can LUK shareholders feel comfortable with that risk?

Handler said that to prevent that sort of thing, they are focused on:

• culture
• transparent, listed securities that settle in a short time; they don't do long-dated, illiquid securities. 
• have systems in place to see positions, VAR etc...
• empower the risk committee

He said no business is 100% safe in any business, but if they stay focused on doing the right things, they can minimize the risk. 

Earnings Power of JEF in a Good Year?

Handler says that the world keeps changing so it would be misleading if he said what JEF can make in a good year.   He said they aim to make low-to-mid teens returns through the cycle (I assume that's ROE, which is consistent with JEF's past). 

Sangart Update? 

This question was tossed to Steinberg who simply said, "It's on life support".   Handler said that it's been written down so the there is upside, not downside (my comment: well, they can keep losing money in which case that would still be downside; just because a problem is not on the balance sheet doesn't mean it can't bleed us through the income statement). 

National Beef
My mind was wandering but I think there was a question regarding Walmart and National Beef.  I just remember some comments about that being a low margin business and the risks of having such a big part of the business with one customer.  I don't know if Klein made it sound like "good riddance", but Handler later stated that even if it's low margin they would have liked to keep the business.

Compensation Ratio at JEF
There was a question regarding the compensation ratio at JEF due to JEF going private.  What are the implications of that (private versus public company).  Handler said it has nothing to do with it.  But he says the comp ratio in the high 50s will come down as that was pushed up by a lot of hiring in the past three years (due to the opportunity).  The hiring has peaked so compensation expensed due to that will start to come down.  Also, as revenues rise, operating leverage should kick in bringing down the comp ratio.

Rising Interest Rates
Someone pointed out that JEF's competitors had a good quarter and JEF was not so great. Handler responded by saying that the volatility in the fixed income markets helps competitors' fixed income derivatives business.  In this environment, that business is like a license to print money.  JEF doesn't have that business, but then they didn't have it four years ago and it blew up some competitors back then.

Monetize or Hold LUK Investments?
They like the businesses they own; good businesses, scalable and throwing off cash.  There are benefits also to the various businesses in terms of idea generation (more eyes on the ground).  Can't say what LUK will look like in the future.  They will just be smart and avoid mistakes.

National Beef
Someone compared National Beef to Smithfield.  Smithfield is two times bigger (revenues and EBITDA)  than National Beef, but the Chinese are paying 4x as much.   Is National Beef worth more?  Klein said that the beef industry always tended to trade at lower multiples than pork.

Infrastructure Investments? 
Someone asked if LUK will get into infrastructure investing.  Friedman pointed out that the LNG business is an infrastructure investment.  But he pointed out that the usual 'infrastructure' investments like toll roads and things like that are for rate-of-return capital;  it is a fixed income alternative so there is a lot of capital chasing those deals.  Fixed income alternative / rate-of-return-type deals just isn't LUK's business.

How Does Handler / Friedman Allocate Time Between LUK and JEF?
Handler pointed out that the various businesses have their own CEOs (and on the JEF side, I guess division heads) and other operating managers that do their job well.  Handler said that it feels like he spends 60% / 60% between the two.  So I take that to mean he splits his time 50/50 between the two.

What is a "Dumb" Thing?
Someone asked, what exactly is a "dumb" thing?  Handler keeps talking about avoiding doing "dumb" things, but mistakes are obvious usually in hindsight.  So what exactly constitutes "dumb"?

Handler said he has been in the business a very long time and has seen very smart people do very stupid things.  He talked about how a great company levered up 35-to-1 and drove itself off a cliff.  Illiquid products that nobody can value has caused trouble.  Bad emails (referring to the Fabulous Fab trial going on at the time).  Avoid arrogance, thinking that you can't make a mistake.  Always have humility and excess capital.

Steinberg jumped in and said that in a nutshell, you don't want to have a margin call.  If you have a margin call, you're finished.  That's what LUK has been about.

Share Repurchases
Berkshire Hathaway has a 1.2x BPS repurchase policy.  What is Handler's view on buybacks?  Have they done any?

Handler said they bought some JEF stock back at the time of the merger.  Post merger, they have a 25 million share authority.   They will be opportunistic on share repurchases.

Does Book Value Approximate Intrinsic Value?
Handler said "that's your decision, not mine".

Which is More Important:  BPS Growth or Shareholder Return?
Handler said early on that they will focus on increasing BPS.  But Handler said shareholder return of course is the ultimate goal, but growing BPS will drive that shareholder return.

Who Makes Decision on Non-financial Acquisitions?
The questioner said something about how LUK built a team and Steinberg said that he never thought of it that way, but they have a great team.  On acquisitions, the board will make the decision.   The questioner probably wanted to know who is going to drive the process when an idea comes up; will it be Handler, Friedman, Steinberg?  I would guess they would all discuss it together so no one person is going to make the call.  They then present it to the board etc...

How Does Steinberg Manage His Time?
Someone asked about his new role, and how he will be spending his time; does he come to work every day? After talking about new office arrangements and some moves (Justin Wheeler moving to NYC etc...), he just said, "We're having fun".

Bank Deals
Someone asked about a small bank deal that JEF was involved in recently.  Is this a trend? Will they see more bank deals?  Friedman said that JEF had a good market share in that sector this week (or last week). This is not driven by Dodd-Frank, but more from capital requirements.  JEF has been waiting for a wave of deals here, but it hasn't really happened, but it will eventually.  The biggest barrier to the deal flow in this area is 'cultural'.  People don't want to give up their CEO-ship.


I don't know if that was the last question, but that's the last thing in my notebook.

Anyway, the meeting started promptly at around 10:00 a.m. and I think it ended at 11:45 am or so (I don't take notes on that sort of thing so I may be off).

I think Handler and Friedman were really good and reasonable and do seem to share the same sort of values as Cumming/Steinberg.   I personally don't have any problem with Handler/Friedman.  I do understand that many in the value investing community are just totally allergic to investment banks.  There is nothing I can really say to those folks.  If they don't like investment banks and bankers, well, then they should just avoid them.   That's totally fine.

But this is not the old LUK either.

13% and 15% Pretax Returns Now!

Banks/financials have been announcing earnings and they have been looking pretty good even though there is debate about the quality of some of the earnings (reserve releases etc.).  There is a lot to talk about but I just thought I'd make a quick update on Wells Fargo (WFC) and J.P. Morgan (JPM) as I have talked about them a lot here.

Buffett's 10x Pretax Earnings / 10% Pretax Yield Idea
I am just going to look at the simple Buffett metric; pretax return on investment.  I've mentioned this metric on another WFC post not too long ago.  Buffett has said in a recent annual meeting that he would like to pay 10x pretax earnings, Alice Schroeder (Buffett biographer) has said that that's all Buffett wants to do; make a 10% pretax return on his investment with little risk.  Munger also used WFC as a benchmark investment against which other potential investments would be compared a while ago; is the potential investment more attractive than WFC?  I think he said at the time that WFC is priced at a 10% pretax yield so if something doesn't measure up to that, why bother?

WFC Pretax Earnings
For the past four quarters, here is the pretax earnings trend for WFC:
   
                    Pretax           Preferred                Pretax
                    earnings         dividends               earnings (less preferred dvd)
2Q2013       8,471             247                       8,224
1Q2013       7,640             240                       7,400
4Q2012       7,221             233                       6,988
3Q2012       7,510             220                       7,290
                  30,842             940                     29,902

So on a trailing twelve month basis, WFC has earned $29.9 billion pretax (and after preferred dividends; I ignored minority interest as it is small).

WFC is now trading at around $44.00, so with 5.3 billion shares outstanding, that's a $233 billion market cap; WFC is trading now at a 12.8% pretax yield on a trailing twelve month basis.  12.8% pretax yield in a world of 2.5% interest rates is pretty attractive (of course, I would never price a stock to a 2.5% pretax yield, though!).

I don't think there is any doubt that Buffett still finds WFC attractive at these levels (he has been buying more all year).  Using his 10% pretax yield, or 10x pretax earnings valuation, he would probably be buying WFC (as long as he is allowed to) up to $56.   That's almost 30% higher than here.  And keep in mind, if I understand everything I've read about Buffett, $56/share for WFC is a price that he would be interested in buying the stock, not some notion of intrinsic value, fair value or anything like that.  It's a price that he would be willing to pay.

There are some issue with banks that people worry about, but we'll look at some of that later.

JPM Pretax Earnings
So let's take a look at another favorite on this blog.   JPM also announced pretty good earnings even though some argue that reserve releases make the number not so high quality.

First, let's just look at the numbers:

               Net to
               common                 Income      
               shareholders           tax             "Pretax income"
2Q13      6,101                     2,802          8,903
1Q13      6,131                     2,553          8,684
4Q12      5,322                     1,258          6,580
3Q12      5,346                     2,278          7,624
             22,900                     8,891        31,791

For pretax earnings here, I just took the net income to common shareholders and added back income taxes paid.  JPM is now trading at around $56, so with 3.8 billion shares outstanding that's a market cap of $213 billion.   That's a 14.9% pretax return, not bad at all.  We can see why Buffett likes JPM (assuming he still owns it.  I don't think anything has happened recently to suggest he doesn't own it; the whale loss didn't seem to bother him at all).

Using the above measure, Buffett would pay up to $84/share for JPM (10x pretax earnings); that's 50% higher than here.  Again, this is what Buffett would be willing to pay.

Yes, but... 
I know.  Many don't see current bank earnings as sustainable.  Reserve releases and a friendly Bernanke is really helping the banks (although we can argue that buying bonds is not helping banks as it flattens the curve (offset recently by a refinance boom that is tapering off)).

On the other hand, one can see the economy as still very subdued and not really recovered.  Housing is still running way below historical trends, and of course, the interest margin is arguably at an unnaturally low level that would eventually normalize.  Also, legal and other costs are elevated due to legacy problems from the financial crisis.

Anyway, let's take a look at what JPM says they can earn on a more 'normalized' basis from their investor day presentation earlier this year.

JPM has long said that under a more 'normal' environment (escalated credit and legal costs come down etc.), they can earn $24 billion in net income.  This is the slide from the investor day presentation that shows this:

This is assuming no change in the environment, but just a normalization of the recent big items.  Just for reference, the last twelve months net income for JPM came in at $24.4 billion.

And another slide showed there are growth initiatives that should allow JPM to earn more than $24 billion over time.  Dimon didn't say when earnings would get to $27.5 billion shown below, but said that the initiatives are close to being in place or will be in place soon so are not longer term targets, so he hinted that $27.5 billion can come soon too.  This is not some medium/long-term project/target.

Using the $27.5 billion ''normalized" figure including growth intiatives and $1.3 billion in benefit from a 100 basis point increase in interest rates, that would come to $39.3 billion pretax (assuming 30% tax rate), and deducting $1.5 billion for preferred dividends and "dividends and allocation of undistributed income to participating securities" leaves us with $37.8 billion.   With 3.8 billion shares outstanding and a $56 stock price, that implies an 17.8% pretax yield.  That's pretty interesting.

Again, not wearing rose-colored glasses, but borrowing Buffett's glasses, it looks like Buffett would be willing to buy JPM up to $99/share!  That's 77% higher than the current price of $56.   Another way to put it is that JPM is trading at 60% of what Buffett would pay for it.

The reason why I went back to these slides is to show that recent trends is within what JPM considers a normal range of earnings.  Even though JPM had great earnings due to reserve releases that can't go on forever, it shows that earnings can grow even without that as other areas 'normalize'. Banks may be benefiting in the short term by dramatically improving credit trends before other areas pick up, it doesn't mean that earnings are unsustainably above trend.   Of course, if other areas don't pick up, then recent trends may be unsustainable.

But, but...
Another big issue, of course, is the leverage ratio.  A lot of questions on conference calls is about leverage ratios.  This is obviously a factor.    Many seem to think that higher leverage ratios will mean that banks can't make money as they did before.  But I think this is not linear, necessarily.  There will be an impact for sure, but these will be priced into bank products.

For example, if a bank had 1% return on assets and had a leverage ratio of 5% and therefore earned 20% on capital and then suddenly the minimum ratio was bumped up to 7%.   This will obviously reduce the return on capital from 20% to 14%.  But what will happen over time is that banks will reprice their loans/products such that they make a reasonable return on capital.  In the above case, the banks would have to earn 1.4% return on assets to make a 20% return.   Loan prices would have to rise 40 basis points (actually, loans would be only a portion of total assets so other assets would also have to increase 40 bps).

This is just an example using random numbers to make a point so not realistic.  I may take a closer look once the dust settles on the rules.  I don't think loans/products will reprice immediately to maintain return on capital, and I don't know if they will be able to reprice to go back to the old returns.  But things will move in this direction.

A key point to remember is that this rule will apply to all big banks, so repricing should happen across the board.  It's just another increase in the cost of business that will eventually be passed on to the customer.  In that sense, this will have implications for monetary policy, of course, similar to raising the fed funds rate.

The problem, as Dimon pointed out, is if the U.S. has a more stringent leverage rule, it may put U.S. institutions at a disadvantage against other global banks.

Rising Interest Rates
The other issue is rising interest rates.  We can't really argue both ways.  We can't be upset with decreasing long term rates as it puts pressure on NIM, and then be worried about rising rates because that will kill the refinancing boom.

What do I think?  Well, I like WFC, JPM and other financials, but it's not conditional on interest rates.  For example, I don't say I like JPM with treasuries at 2.0% but hate it at 5.0%.  This really makes no sense to me.  I've been involved in the markets for a long time and I've seen all sorts of interest rate forecasts so the last thing I would do is invest based on a view on interest rates.

(At a firm I worked, I laughed at the resident economist who said that the Fed Funds rate will go down to 5%.  It was 8% at the time.  And then he said it will go to 3% and then I laughed even harder.  etc... You get my point.)

I like these well managed financials because, well, they are well managed. It's not because I think interest rates will stay here, go down to 2.0% or won't go above 3.0% or anything like that.  I have confidence that the management at good banks will do what is best in each respective scenario; I will let them worry about it. If I didn't think they could handle fluctuating interest rates, I wouldn't own them.  And they have been stress tested. Not by the Fed or a regulator, but by a serious financial crisis.

Off-Topic Tangent
OK, so the above thought on interest rates reminds me of a conversation I had recently.  I was talking to a guy who is really into value investing.  He is and has been studying value investing for a few years and it's his main passion/hobby (not his main job).  So I emailed him a whole bunch of stuff including book recommendations, told him to make sure to read Buffett's letter to shareholders, the article "Superinvestors of Graham and Doddsville" and the other usual stuff that we all read.

Then a few weeks later, during the market decline in June, I ran into him and he was very excited because he told me he sold out right before the sell-off  (I saw him the other day but didn't ask him if he bought back in...).

Well, he did tell me that he is a value investor and not a trader so I was a little surprised.  How can you do all the work and analyze companies, buy them and then just turn around and sell them just because the bond market goes down a little?  If you evaluate and like a business with treasuries at 2.0%, you should feel comfortable owning it with treasuries at 3% or 5%.  If not, then maybe it's not such a great business.  If you won't like a business if rates go up, then one simply shouldn't buy that business to begin with (because rates will go up, eventually).

This also reminds me of a cardinal rule of trading; if you buy something for one reason, don't sell it for another.  Of course, unless the other reason is a really good, valid reason to sell a stock (fraud uncovered, unfavorable management change, long term decline or permanent impairment of business etc.).

Anyway, time and again, I run into people who love and own this or that stock, but then they later tell me they sold because they feared a U.S. debt default, fiscal cliff, meltdown in Greece, bond market crash or some such thing.

Buffett wrote a comment (which Seth Klarman also said) in the "Superinvestors of Graham and Doddsville" article that this value investing idea is something people either get right away or not at all.   Time and again, people will do one thing (rational) and then out of fear or greed turn around and do something that makes no sense. He is so right.

If you do all the work, read the annual reports, 10-k's, 10-q's, understand and like the business and the valuation, then go ahead and buy the stock.  But please don't sell the stock just because everyone says that the bond market is going to crash and that stocks will follow it down!  If a company you are looking at is going to go bankrupt if a recession hits or if interest rates go up to 5%, then the right thing to do is to not buy that stock to begin with.  Don't buy it and try to sell out before the next recession or before rates start really going up because that sort of strategy doesn't work unless you are a really good macro trader (and those are rare!).

Yes, there are people who make a living doing macro trading.  But macro traders spend all of their time looking at macro trends and placing bets according to their own deep analysis of what they think is going on. It makes no sense for value investors who spend their time looking at businesses and financial statements to be a value investor one day and then a macro trader another (buy a stock on business fundamentals one day and then sell on another day for macro reasons).  When you really think about it, the sudden turning of value investors into macro traders is usually emotionally driven (fear), not by logic.

If you look at the great wealth created over time, most of it is created by people who buy and hold good assets; it is not created by dancing in and out of holdings (especially motivated by things that are simply unknowable).

But I know, I am preaching to the choir, but I can't resist as the above scenario happens to me all the time (and I'm sure many readers have the same experience).

Conclusion
I still like the financials.  My only reservation is that they are getting more popular.  But valuations are valuations and they are reasonable.  I looked at WFC and JPM from a slightly different viewpoint from what is common (usually looked at on a P/B or P/E basis) and find it interesting.

There are obviously a lot of risks here.  Interest rates can turnaround and head down and really continue to push NIM down and the economy can stay here or deteriorate making banking a horrible business.  Inflation can pop up and make rates go up in a bad way.  If rates go up due to a strengthening economy, that would obviously be good for banks regardless of what happens in the short term.  Over time a stronger economy would increase loan volumes and help other areas and rising rates would get NIM back up and increase profitability.

Yahoo - Alibaba Group

So I can't believe it's been more than a month since my last post.  This was not an intended leave or anything like that, time just flew by.  Preparing for the summer, going away and things like that.

Anyway, I do intend to keep posting here regularly.  Hopefully I don't have a gap of an entire month too often.

A lot of things are going on now and there are a lot of things to look at and talk about, but for now I just thought I'd look at Yahoo!, or more specifically, the Alibaba Group.

In the earnings release, there was a new slide that I didn't see before which includes the earnings of Alibaba Group.  These figures have always been disclosed in the 10-Q and 10-K's, but I don't remember seeing it in the earnings slides.

It would seem a little odd that something that has been known and disclosed for a long time suddenly gets noticed because it's on a colorful slide.

Anyway, let's take a look at it:

Let's just zoom up on the relevant table on the left:

So, we know that Alibaba Group is doing extremely well.  We all knew that, of course, but it's now even more known.  It's interesting that analysts are now rushing to up their value of Yahoo! based on an increased valuation for Alibaba Group.  I suppose the market/analysts are responding to what looks like some serious operating leverage kicking in (well, it kicked in last quarter too but people didn't seem to get this worked up about it).  Hopefully, that's real operating leverage (that is sustainable).

Anyway, so let's take a look at this thing.  I posted a couple of years ago how some thought that Alibaba Group was worth $32 billion, and last September YHOO sold some shares back to Alibaba Group validating valuations in the $30-40 billion range.

Since then, people have been talking about $100 billion for the valuation of Alibaba Group, and today I think some are saying it's worth $120 billion.

I really don't have any idea how these things are supposed to be valued, but I decided to take a closer look to see if I can get some sort of feel for it.

Alibaba Revenues and Earnings Trend
First of all, here is the trend of Alibaba Group's revenues, operating earnings and net profit (attributable to Alibaba Group):

So this is remarkable.  Revenues have been growing consistently around 70%/year and it has turned profitable since 2011.

Let's take a closer look at this on a quarterly basis:

This is pretty impressive for sure, and you can see why the market is responding to this.  Operating margin is up to over 50%.  We don't have details on Alibaba's financials, so it's hard to say where margins will be over time.  But if they keep growing revenues like they have been and keep margins in the 30%-50% area, this can be a huge market cap company for sure, no doubt about that.  With real earnings, this is no longer just a pipe dream, dot-com.

This is not so safe to do without knowing more details, but if you annualize the first quarter 2013 (ended March 2013) earnings figure that comes to $2.7 billion.  If you value Alibaba at $40 billion, a figure tossed around not too long ago, that would be less than 15x earnings annualized current earnings, which of course is ludicrous for a profitable business growing revenues at 70%+/year.

Taking this $2.7 billion figure, Alibaba would be worth $54 billion at 20x p/e.  20x would still be way too cheap.  OK, instead of looking at it like this, let's make a table out of this.

Alibaba Valuation: 
                     
                                     Value of                             Value per
P/E     Total Valuation    YHOO stake (@24%)      YHOO share
20x     $54 billion           $13 billion                         $13/share
30x     $81 billion           $19 billion                         $19/share
40x     $108 billion         $26 billion                         $26/share
50x     $135 billion         $32 billion                         $32/share
100x   $270 billion         $65 billion                         $65/share

The value is before any taxes that would have to be paid on a sale.   When Facebook came out, it came out at something like 100x earnings and 27x revenues.  At 100x p/e, Alibaba could be worth $270 billion, or $65 per Yahoo share, which is nonsense.

First of all, I am using a figure annualizing the 1Q net income figure which is not always a good idea.  But on the other hand, this doesn't take into account the 70% revenue growth through the rest of the year.  If they continue to grow revenues and maintain or improve margins, then annualizing the 1Q figure would be too low.  There may have been factors that pushed up margins in the 1Q that may not recur.

But anyway, even taking a valuation like 40-50x, which would seem reasonable (not that a value investor would pay that price!) for someone growing revenues so quickly, this would value Yahoo's stake (pretax) at $26-32/share.

YHOO has agreed to sell half of their existing stake in the IPO, so it seems the longer that takes, the more value YHOO can get.

This is really sloppy analysis, but if we push this out a year and assume revenues keep growing at 70% and margins stay up here at 50%, you can just push up the above valuation figures another 70%.  The potential is just insane.

China Crash
One problem that people seem worried about now is the China meltdown.  One thing to keep in mind is that during the financial crisis, companies like Google, Facebook, Amazon and others kept growing and did just fine; they are in growing businesses taking share away from the old economy so the biggest financial crisis / near depression was barely noticeable in their financial statements through the crisis.

In that sense, Alibaba Group exposure may not necessarily carry the same risk as other China-themed investments.

Conclusion
I really don't have any idea if Alibaba will keep growing at +70%/year, or whether 40-50% operating margins are sustainable.  And I didn't intend to fine-tune intrinsic value of YHOO; I just wanted to see what all the hullabaloo was about and in this case, there does seem to be something there.

I have no idea what the proper valuation for Alibaba is, but from the above table, I actually don't think a $100+ billion market cap is a stretch for Alibaba.

I do still own YHOO, primarily for the reason I stated in previous posts (sum-of-the-parts valuation), although I have lightened up as YHOO rallied a bunch.  But it's amazing how much value is being created here in Alibaba.

Do I have a view on Marissa Mayer?  Not really.  She does seem supersmart and well-liked.  It's really good that morale is up which is really important for companies.  But whether or not she can turn around YHOO is a tough question.  I have no idea.  I lean towards being optimistic and do think she has a chance, but it's a tough, fast-changing industry.  She certainly seems to be more qualified to run YHOO than other recent CEO's (who were not Silicon Valley 'geeks'.  Bartz was a tech industry executive, but from another era and didn't seem to have the hacker cred that seems so important)

Anyway, YHOO is certainly still very interesting and I will continue to watch this.  After looking at this data in this form, I almost wish YHOO wasn't in a rush to monetize some of these assets.  Imagine what Alibaba could be worth in a another couple of years.  But then again, who knows when things turn.