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.

YHOO Deal?

There is talk out there that Softbank and Alibaba is going to bid $17 billion for Yahoo's Asian holdings in some sort of tax free deal.  I don't know what the real term sheet looks like, it was just on CNBC.  But let's take a quick look to jot down some of th facts.

Here's the basic information:
(grabbed from the CNBC screen)

• 40% of Alibaba ($12 billion)
• 35% of Yahoo Japan ($5 billion)
• Yahoo keeps 15% stake in Alibaba
• Tax-free, cash-rich split
• Yahoo "core" valued at $6/share?

I don't know what the last item valuing Yahoo's core business at $6.00 means. The stub value after deducting the $17 billion on the deal is $2/Yahoo share.

Actually, dividing $17 billion by the 1.24 billion shares I think is outstanding gives $13.70/share, and Yahoo is trading around $16/share so that gives the Yahoo operation a value of $2.30/share.

But actually, the 3Q figures show that Yahoo has cash, cash equivalents and bonds worth $2.87 billion on the balance sheet.  That's $2.31/share, so the market is actually giving the Yahoo "core" business a value of zero.

So here's my math:

Yahoo's Asian holdings:  $13.70/share
Cash, cash eq and bonds on balance sheet at September-end 2011: $2.31/share
Total:  $16.01

Stock price: $16.00

Implied value of core business: $0.00

What is this business actually worth?  Here's some info for the last four quarters of Yahoo's core business:

For the last four quarters through September 2011, Yahoo had total revenues (excluding traffic acquisition costs) of $4.4 billion and operating income of $778 million.  Using a 35% tax rate, that is a net income of $506 million or so and with 1.24 billion shares outstanding that's around $0.41/share in EPS.  This is also very close to free cash flow per share.

At a 10x p/e ratio, that would value Yahoo's core business at $4.10/share giving a total value of $20.00/share or so for the whole of Yahoo (including the Asian holdings).  I think I heard an analyst mention the value of Yahoo at $20/share, so this calculation is not far off.

If you assume a 10% free cash flow yield for Yahoo's core business, we can get a similiar figure. With free cash flow in the past four quarters of $560 million, that's $4.51/share, so not too far off from using a 10x p/e multiple (which gives a $4.10/share value).

As of the end of the third quarter, Yahoo's guidance for the 4Q 2011 was:

Revnues: $1,125 - $1,235 million

Operating income:  $200 - 260 million

Using the midpoint of this guidance, you get 4Q 2011 revenues of $1,180 million and an operating earnings figure of $230 million.

So doing the above exercise using a 2011 fully year projection would result in a figure that is pretty close to the last four quarters.

The problem with the above analysis is that revenues at Yahoo has been declining 4-6% year-over-year in the past four quarters.  If this trend continues, it's possible that Yahoo may not be worth the above.  It may well be worth much less.

Alibaba Worth $32 Billion, Yahoo Worth?

Figuring out the value of Alibaba Group was a bit of a parlor game as Alibaba Group has dominant businesses that are not listed.  Alibaba.com is the only listed entity in the group.

The value of Alibaba Group is a crucial factor in determining the value of Yahoo Inc. (YHOO) stock.   I posted Dan Loeb's analysis here.  This is based on his letter to the YHOO board in September 2011 so the values are still pretty fresh. 

Anyway, it was reported last night that DST Global and Silver Lake Partners will invest up to $1.6 billion in Alibaba Group, valuing the whole group at $32 billion.    The buying group includes Yunfeng Capital which Jack Ma owns. 

This is interesting in a couple of ways.  First of all, the fact that Jack Ma's Yunfeng Capital is in the buying group is encouraging in that it means Ma thinks this is a good price (to buy Alibaba Group).  It's nice when the founder and owner validates a valuation by purchasing a stake at that price.  This is the opposite of owner/founders selling into an IPO, for example.

Second of all, the fact that Silver Lake Partners and other institutions are buying into this also starts the clock on an IPO or some sort of exit strategy for Alibaba Group.   Private equity firms typically buy unlisted companies looking to get out via a sale or IPO.  In this case, the exit is likely to be an IPO as large high growth technology companies typically do an IPO instead of sell itself privately to another entity.

Why is this interesting?  When Yahoo Inc. and Softbank were arguing with Jack Ma about their stake in Alibaba Group and Alipay, Ma has stated that he has no intention of doing an IPO for Alibaba Group.  He said it was completely off the table and not even on the horizon.

The fact that private equity money is coming in changes that a bit.   I doubt Silver Lake would invest in an open-ended situation.  The clock is going to run now like it hasn't before.   Also, the fact that a private equity firm has bought into Alibaba at a $32 billion valuation implies that Alibaba is worth far more than that.  Private Equity firms don't buy stakes at fair value.  They only buy with an expectation of high return.

This, of course, is good for YHOO, as they now have 'allies' with interests in seeing their Alibaba stake monetized.  And of course, an IPO would be the best way for YHOO to monetize the position if they can spin it off tax free(as opposed to selling their Alibaba stake in a private transaction that might give YHOO a hefty tax bill).

So what is YHOO worth now?  I still think Loeb's analysis is not far off and is a very conservative view.

But let's take a look at a simple view assuming they can spin off these positions tax efficiently at some point.

Here are the big peices of YHOO's value:

Yahoo Japan stake:        $6 billion
Alibaba Group:              $12.8 billion (40% of $32 billion)
Total:                             $18.8 billion

Yahoo also has a lot of cash, cash equivalents, short term debt securities and long term debt securities.  The total of that is $3.26 billion.

All of that together gives you $22.06 billion in value before considering YHOO's operating business.  This $22 billion comes out to $17.51/share, versus a stock price in the $14.70.

What is Yahoo's operating business worth?  Nothing?  I think not.  In the first half of 2011, YHOO's operating business generated net income of $272 million.  This excludes income on investments and equity income and is after tax.

Annualize that and you get $544 million.   That comes out to $0.43/share of eps.  At 10x p/e, that comes to $4.30/share in value.

Add that to $17.51 of cash, investments and their Asian holdings, that comes out to $21.80/share.

If you assume a 40% tax rate on their Asian holdings, the total number would be a bit lower.  Total investments and cash would be $11.56/share.  Deduct that from the current stock price of $14.70 and you get $3.14 price for the operating business that is earning $0.43/share.  So that's a p/e of 7.3x p/e.

In any case, that's just a quick look at Yahoo.  There is a chance that YHOO is worth far higher, as Loeb says, due to the growth of Alibaba and even slight operational improvements in YHOO's main, U.S. business.

Yahoo Worth More Than $20/Share!

Yahoo has been an interesting 'stub' trade, or sum-of-the-parts play by some prominent value investors.  Most recently, David Einhorn of Greenlight Capital took a large stake and then dumped it when he was frustrated by the problems caused by Yahoo's handling of the Alibaba/Alipay situation.

This story got a bit interesting again as the board fired Carol Bartz, the CEO brought in to fix up Yahoo a couple of years ago.

And then we get Daniel Loeb of Third Point (an $8 billion assets under management hedge fund) taking a 5.1% stake in Yahoo for the same reason that Einhorn did; the value of Yahoo when looked at as the sum of the parts is far higher than the current stock price  (5.1% is worth $918 million or so and that constitutes more than 11% of Loeb's AUM, so that's a serious position).

I do own a little bit of YHOO too but I'll use Loeb's numbers to illustrate the value here.  It's not often that we get a detailed look at how a prominent, usually very secretive and private investor sees value in a specific situation.

From his letter to YHOO's board, his take on the value of YHOO stock is:

 Value per share of YHOO:
  $2.49  tax adjusted net cash
  $3.10  stake in Yahoo Japan (after tax)
  $5.24  stake in Alibaba  (after tax)

Deducting the value of these holdings from the current Yahoo stock price (or current at the time of this letter, September 8, 2011) of $13.61 leaves $2.78 as the implied value of Yahoo's core business.  This is a valuation of 2.2x EV/EBITDA which is very cheap.

If the business is refocused and fixed, it can be worth 7.0x EV/EBITDA giving the whole value of Yahoo shares of $19/share, or 40% higher than the current price.

If they can distribute their Asian holdings in a tax efficient manner, there may be an additional $3-4/share to be realized putting the value of YHOO shares into the mid-20's.  

The letter talks about the medium-term potential of Alibaba, which can add another $5.00/share in value over time as Alibaba's business in China continues it's high growth.

Loeb is right that the board of Yahoo seems to have mishandled a bunch of things, and the board should probably go.  Everything from rejecting Microsoft's $31/share bid to hiring the wrong person (Bartz), to publicly announcing full support for this wrong person to the sudden firing by phone of this wrong person etc...

The board may or may not go, but I do think the pressure is on; there is a lot of pressure to do something to increase value to shareholders and this Bartz fiasco has certainly accelerated whatever must happen eventually. 

I do think this is pretty interesting.