Academics love to say that the market is efficient and reflects all publically available information with Vulcan-like logic and lack of emotion.
Yet any third-grader with experience in a sandbox knows that’s not true. Manias, panics, enthusiasm, dejection, envy and regret cloud traders’ judgments, and result in persistent mispricing.
It looks like some of that mispricing is at work in fallen web giant Yahoo! (YHOO), which appears to be trading at a level that assigns its core business at a value of -$5 per share. All of the rest of its $44/share valuation, and more, accrues to its stake in Chinese web phenom Alibaba (BABA).
Investors in short are saying that Yahoo’s portal business, its award-winning mobile apps, its new Screen original content initiative, Tumblr, and its cash on hand are actually worth less than zero.
Morgan Stanley analysts who initiated coverage late last week believe this is overly harsh, setting the stage for a rebound as sentiment recovers and valuation rises to a more reasonable level.
Yahoo! remains a sum-of-the-parts story until its remaining 15 percent stake in BABA is spun off later this year in a tax-efficient way, so let’s break it down:
— Alibaba
Buying YHOO at current levels not only gives access to its core business on the cheap but it provides exposure to BABA at about a 20 percent discount to fair value, according to Morgan Stanley’s Brian Nowak and estimates by analyst Brian Lin. Although BABA’s earnings growth is expected to slow to 9 percent this year (due to acquisitions and capital expenditures) income should rebound in 2016 to a 37 percent pace.
This 20 percent discount includes an 11 percent liquidity and tax discount on YHOO’s stake in BABA since it is an open question as to how the company will spin off its holdings and what happens afterwards. This reflects the risk the spinoff is subject to U.S. corporate taxes at some point down the road.
— Yahoo! Japan
Yahoo!’s 36 percent stake in separately held Yahoo! Japan is worth $7.32 a share according to Nowak, who then uses a 20 percent discount in his valuation model to reflect the fact it is unlikely a spinoff or other form of monetization will happen. Yahoo! Japan is a joint venture with Softbank.
— Yahoo! Core
The company’s core business, in Nowak’s estimation, should be trading at a 4.5x multiple of his 2016 operating earnings estimate of about $1 billion — a 15 percent discount to AOL (AOL) and the New York Times (NYT). This, along with Yahoo!’s net cash, should be worth $9.23 per share. While renewal negotiations with Microsoft on the search partnership dating to 2009 are heating up, there are positives here such as audience trends in its mobile display business — an area of growth for web companies in general as the text search ads stagnate.
Overall, Morgan has assigned a price target of $55, which would be up 25 percent from current levels. We will know soon enough if the math adds up.
Best wishes,
Jon Markman
