Steven Romick (Trades, Portfolio) is the portfolio manager of FPA Crescent Fund. As of Jan. 31, the fund has delivered more than 11% a year in average returns over the past 10 years. His fund has about $2.8 billion under management. Romick's portfolio consists of equity positions of both long and short. He also has sizeable positions in short term bond and cash. He seeks value in all parts of a company's capital structure, including common and preferred stocks, as well as corporate and convertible bonds. The manager invests in securities "that the consensus does not wish to own," searching for stocks and convertible bonds that reflect low price/earnings ratios (P/Es) and trade at discounts to private market value. Corporate bonds with yields substantially higher than those of government securities are also considered.
Last quarter, he initiated a long position in Yahoo! (YHOO, Financial) by buying 3,409,200 shares. Yahoo's appears grossly undervalued. The company's stake in Alibaba (BABA) is worth ~$40 billion and Yahoo Japan is worth ~$7 billion. Yet Yahoo's market capitalization is just $42 billion, giving a negative value to its core business.
The recent plan of management to hive 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!.
Post spin-off 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.
Yahoo's current valuation and stock price movements are more reflective of its stake in Alibaba rather than its core business fundamentals. Once the spin-off is complete, I believe the focus will shift to Yahoo's core business. Many investors believe that Yahoo's core business, which is seeing year-over-year declines, is actually a value destroyer and worth close to nothing. I disagree with this argument. If one takes a closer look at the company's recent performance, he/she would see that while the company's traditional display advertising business is witnessing a decline, there are packets of strength. The company's mobile, video, native and social business (which it calls MaVeNS) is growing and becoming meaningful enough to offset the decline in its traditional display advertising business.
Last quarter, the company's mobile revenues were $254 million, up 23% sequentially from Q3. The company's mobile apps continue to win accolades. Google Play recognized Yahoo! News digest, Yahoo! Now and Tumblr on their best apps of 2014 list. Apple iOS store also recognized four Yahoo apps – Yahoo! News digest, Flickr, Yahoo Finance and Yahoo! Weather – on its best apps of 2014 list. The company's MaVeNS business grew 100% year-over-year in Q4 and going forward is likely to more than offset any decline in the company's display advertising business.
I believe Yahoo! is on a verge of turnaround in its core business. The impending spin-off of Alibaba's stake will improve the valuation transparency of the company's core business and its holding in other companies. This will likely serve as a catalyst for the stock.
