Verizon Communications Inc. (VZ, Financial) announced a near $5 billion acquisition of Yahoo! Inc. (YHOO, Financial) on July 25. With declining financials, the pioneer Internet company is likely to face bankruptcy in the short term. By acquiring Yahoo!, the management team at Verizon can produce synergies that benefit both companies in the short term.
The acquisition deal and its background
As mentioned in its July 25 8-K filing to the Securities and Exchange Commission, Verizon will acquire Yahoo!’s equity and core business for $4.83 billion. While Yahoo! will maintain its holdings in Alibaba Group Holding Ltd. (BABA, Financial), the Internet company will transfer all assets and liabilities pertaining to its core business to Verizon. The deal is expected to close during the first quarter of 2017, subject to approvals from Yahoo!’s shareholders and antitrust committees.
During the past fiscal year, Yahoo! suffered a net loss of $4.773 billion according to its 15-year financials. This resulted in poor valuation and profitability ratios: although the company’s financial strength and profitability rank both scored a 6, Yahoo!’s operating margin and Greenblatt return on capital currently underperform 93% and 83% of global Internet content and information companies. Worse, the Internet company’s Greenblatt ROC reached a new low of -304.15%, about 20% lower than the historical minimum.
Although Yahoo! had steady operating margins from 2006-2015, the company’s operating margin dramatically tumbled during 2015. In its 10-K filing for fiscal 2015, management at Yahoo! described likely reasons for the sharp decline in margins. Due to goodwill impairment charges of $4.46 billion, the pioneer Internet company had operating expenses of $9.72 billion during fiscal 2015, about twice as high as its operating expenses for fiscal 2014. Sharp contractions of Yahoo!’s market cap during the fourth quarter of 2015 likely resulted in deep losses in the carrying value of the company’s goodwill.
Verizon finds synergetic value in Yahoo’s core business
After acquiring AOL Inc. (AOL, Financial) for $4.4 billion during the summer of 2015, Verizon expects to fortify its mobile media operations by acquiring Yahoo!’s core business. As mentioned in the July 25 press release, the Yahoo! acquisition would make Verizon the “top global mobile media company,” allowing Verizon to have a highly competitive position in the global Internet content and information industry.
Yahoo! CEO Marissa Mayer cherished the deal announcement, which could help accelerate Yahoo!’s work in many fields including advertising, social and networking. By joining forces with AOL and Verizon, Yahoo! can extend its momentum in the mobile business. Tim Armstrong, CEO of AOL, further highlights the benefits of such a merger: the acquisition allows AOL to build on Yahoo!’s strong business model and strengthen the overall growth of Yahoo!. Additionally, the acquisition will build a strong portfolio of the largest brands in advertising and media. The combined operation of Yahoo!, AOL and Verizon is likely to produce a major mobile media firm that can highly compete with online media giant Alphabet Inc. (GOOG, Financial).
Conclusions and next steps
While the synergies benefit all three companies, the acquisition is still subject to approvals from antitrust committees and shareholders of Yahoo!. Like all acquisitions, the Verizon-Yahoo! deal is also subject to “customary closing conditions,” similar to those discussed in John Paulson (Trades, Portfolio)’s Merger Arbitrage checklist.
Disclosure: The author does not have any position in the stocks mentioned in the article.
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