Last week, Verizon (VZ) announced acquisition of AOL (AOL) via a tender offer of $50 per share. Citigroup’s (C, Financial) analyst Mark May believes that this deal is a positive for Yahoo! (YHOO, Financial) as it shows that there are strategic type of buyers for Yahoo!'s core asset which is available very cheap. In a report sent to investors, he wrote:
“We highlight three points: 1) the minimal premium (17%) and multiple (7.5x 2016 EBITDA) are a reflection of AOL’s below-average growth and margins (especially for its Media/Brand and Adtech businesses) and of its low quality of earnings (i.e. most of the company’s EBITDA comes from its declining Membership/Subscription business). 2) We would not anticipate other bidders given the uniqueness of AOL’s mix of businesses and because we think the multiple being paid relative to growth and profitability is a fair premium. 3) We view this deal as a positive for YHOO as it shows there are strategic buyers for this type of asset and because we view YHOO as a strong asset that is currently only valued at 1x our 2016 EBITDA estimate.”
Yahoo!'s stock appears grossly undervalued. The company's stake in Alibaba is worth ~$40 billion and Yahoo! Japan is worth ~$7 billion. Yet Yahoo!'s market capitalization is just $42 billion. The recent plan of management to spin off its Alibaba holdings into a separate company – Spin Co – by the end of 2015 will remove some of this discrepancy. This structure will improve valuation transparency for both Spin Co and Yahoo!.
The company's core business continues to improve but main focus of investors remains on the monetization of Yahoo!'s stake in AliBaba (BABA) and Yahoo Japan. Yahoo indicated that it intends to "look for sensible ways to realize the value" of its patent and intellectual property portfolio.
According to Morgan Stanley (MS) analyst Brian Nowak, "the core turnaround continues, but YHOO remains focused on monetizing its assets, as it announced it has retained advisors to "determine the most promising opportunities to maximize value" around its 35.5% Yahoo! Japan (YJ) stake.”
Post spinoff, one company will be the currently existing Yahoo! entity which will include the Yahoo! Operating business and its 35.5% equity ownership in Yahoo! Japan joint venture. The second company – Spin Co – will be the newly formed entity which will be a registered investment company and will include Yahoo's 15.4% ownership of Alibaba shares. Spin Co will also include a legacy ancillary active trading business of Yahoo! with ~$50 million in adjusted EBITDA.
The stock in the new company will be distributed pro rata to Yahoo! shareholders. It will be led by an independent and newly appointed management team and board of directors. The composition of Spin Co's board of directors and management team and other details of transaction including the distribution ratio will be announced prior to the close of the transaction. Spin Co will assume no debt as part of transaction, and this distribution will be tax free.
The spinoff of Alibaba stake is almost finalized, and it will improve the valuation transparency of the company's core business and its holding in other companies. Given the type of valuation AOL has received from Verizon, there is a good possibility that Yahoo!'s core business may see a meaningful re-rating. Hence, I am bullish on the company.
