Yahoo! (YHOO) shares have increased to $42.50 from $36.14 since July 3, 2014 when we recommended investors look at buying them based on the value that the Alibaba (BABA) IPO could unlock. Yahoo recently reported its 3Q14 and following a solid performance in a tough market, we wanted to update our valuation and commentary on Yahoo!.
Lower Tax Rate Key Takeaway in Quarter
It was a beat and raise quarter for Yahoo! (YHOO), but while the outlook improved, it did so modestly. Yahoo! reported earnings on October 21, 2014 with both revenue and adjusted EBITDA of $1.094 billion and $306 million, respectively, beating street expectations in the quarter. Revenues at Yahoo were ahead of Street consensus by 5% and EBITDA beat by 22% in the quarter. In addition, EBITDA guidance for the 4Q14 was ahead of Street expectation by 3%. The EBITDA beat was due to higher than expected Alibaba royalty payments and also lower G&A. Non-GAAP EPS was $0.52 in the quarter.
Another big positive, more one-time in nature, was developments around the taxing of proceeds from Alibaba’s IPO. Management expects to pay a tax rate of 35% on the $9.4 billion it receives versus prior expectations that the tax rate would be closer to 38%. In addition, management is investigating tax strategies for its remaining stake in Alibaba and plans to provide an update on or before its year-end call. There is additional upside to Yahoo! shares if the tax rate declines further.
Mobile business is Improving
Also positive for Yahoo!, mobile is growing as a portion of sales. Yahoo made $1.6 billion worth of acquisitions that are helping growth its mobile presence. Yahoo! struggled in the past to penetrate mobile, but management expects mobile will contribute $1.2 billion in FY14. Mobile gross revenues were $200 million in 3Q14. During the quarter, 44% of display ads came from mobile platforms. In the core search business, its clicks were flat year-over-year but the price-per-click increased by 17% versus 3Q13.
Still More Upside to Yahoo Based on Sum-of-the Parts Valuation
Yahoo’s upside in our view is still based on an undervaluation its parts. The biggest upside in the valuation analysis below comes from the upside on the tax rate applied to Alibaba. That said, the multiple applied to Alibaba will has play a big role. We note we did not expand a lower tax rate to its interest in Yahoo! Japan, but one could make the argument it would also decline and increase the value to shareholders.
|Impact of Tax Rate on Value of Alibaba per Share|
|Alibaba Value (12 months)||250||250||250||250|
|Tax Rate on Alibaba||36%||30%||25%||20%|
|Alibaba Post-IPO Value||24||26.3||28.1||30.0|
For Yahoo, so much of the value remains locked up in its equity stakes in Yahoo Japan and Alibaba. The value of its Alibaba equity has a value ranging $26 – $30 per share. This range is based on a 12 month out multiple of 30x 2016E P/E and a tax rate from ranging 25% – 36%. The prior table shows the impact of the tax rate to Yahoo! shareholders. For every ~10% the tax rate drops, the value increases by about $5 per share. We believe the Street has priced in a rate over 30%, anything below that would drive the shares higher.
Yahoo! Japan has a value of about $4.7 billion currently or about $5 per share. Yahoo! has cash of $7.8 billion on-hand, but will have to make a $3 billion tax payment in March 2015, so after that it is roughly worth another $5 per share.
Yahoo’s business at 6x 2015 EBITDA is worth an estimated $8.5 billion or $9/share. The last piece here is Tumblr which we estimate has a value of about $1 billion. In total, we estimate Yahoo’s value as a sum of these parts at $50 per share (see below table).
|Sum-of-Parts (in billions)|
|Yahoo! Core Business||$8.70|
Conclusion – Still More Upside
Yahoo! continues to compete with the Google (GOOG) and Microsoft (MSFT) in the search business. However, this part of the business is not the future of Yahoo!. Management at Yahoo is steadily reshaping the core business while unlocking value for shareholders. It is returning cash to shareholders, and management noted that it has already returned half the proceeds from Alibaba through repurchases. Yahoo has made $7.7 billion in buybacks over the past two years. Second, management has increased the number of acquisitions and started to reposition Yahoo! to make it a growth story. Increasing its mobile presence and the purchase of Tumblr are a good start.
The potential upside based on the sum-of-the-parts analysis, and the belief that management can continue to make solid strategic acquisitions to grow the core business are both reasons to own Yahoo!. The biggest risk at Yahoo! is that management does not succeed in accelerating its growth rate, and the acquisition do not create value for shareholders but destroy