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Alibaba Deal Cheers Investors: What Does It Means For Yahoo?

 May 21, 2012 01:48 PM
 


(By Mani) The wait is over for the investors of Yahoo, Inc. (NASDAQ:YHOO) as the California-based internet firm took a key step towards monetizing its valuable Asian assets.

Yahoo agreed to sell half of its 40 percent stake in Alibaba Group back to the Chinese internet giant for $7.1 billion, out of which $6.3 billion would be received in cash and the balance $800 million in preferred shares. The deal values Alibaba at about $35 billion.

The Alibaba deal would not have come at a better time for Yahoo, which lost its fourth CEO in five years and second in less than a year. The deal comes days after Ross Levinsohn, an internet veteran, took the helm as interim CEO after its predecessor Scott Thompson had to step down over allegations related to his educational qualification.

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On May 14, iStock indicated that with a new board at the helm, Yahoo may make a decision on the asset sale of Alibaba to reinvent itself by investing in new growth areas besides unlocking shareholders value.

The deal paves the way for Alibaba to achieve future public market liquidity for all of its shareholders. For Yahoo, the deal offers a staged exit over time, balancing near-term liquidity and return of cash to shareholders with the opportunity to participate in future value appreciation of Alibaba.

The key question here is where does this deal would take Yahoo fundamentally in the near-term? As of now, answer is nowhere as Yahoo is returning all proceeds from the transaction to shareholders. So, the question of boosting liquidity goes in thin air, especially at a time when it could face cash crunch amid market share losses to Google, Inc. (NASDAQ:GOOG) and Facebook, Inc. (NASDAQ:FB).

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While Yahoo is the leader in display advertising with roughly a one-third market share in the US and holds the number 2 search position with roughly 14 percent share, the company has lost share in both businesses and continues to reorganize to compete more effectively.

Since, Yahoo is way behind the market leader Google's 65 percent share in search market, its only sustainable bet is to capture share in display advertising where it is facing stiff competition from Facebook and Google.

Meanwhile, the ever-increasing amount of display inventory requires constant investment in technology and the company may resort to further restructuring, streamline costs to increase margins.

The only way Yahoo could get some massive cash is to encash its remaining stake in Alibaba when the latter files for an IPO, which would take at least 18-24 months. However, Yahoo would get $550 million from Alibaba in terms of royalties for using Yahoo China for 4 years. Restrictions on Yahoo's ability to make other investments in China will be terminated.

Jack Ma-led Alibaba Group will pursue an IPO at some time, at which time it will purchase half of Yahoo's remaining stake or allow Yahoo to sell its shares in the IPO for cash, and Yahoo will pay US taxes.

Alibaba, whose e-commerce interests hold a dominant position in the "B2B" industry. Alibaba Group's Taobao business is essentially Ebay and Amazon on steroids in terms of market share and revenue growth.

The Chinese e-commerce market was $75 billion in 2010, with a 3 year forward compound annual growth rate of 43 percent, according to Goldman Sachs, compared to the $193 billion U.S. market with compound annual growth of 14 percent over the same period.

Given Alibaba Group's growth potential and market share, it is entirely conceivable that Yahoo's 40 percent fully diluted stake in Alibaba Group could double in value over the next 2-3 years, highlighting its tremendous value.

Good Deal For Investors

Yahoo could return most of the after-tax proceeds from the deal to shareholders, and it raised its buyback authorization by $5 billion. The company would pay about $2.5 billion in taxes in the US and use $3.8 billion to repurchase shares.

The deal is a win-win situation for investors, who have been urging Yahoo to dispose its stake in Asian assets since it rejected a $47.5 billion, or $33 a share, offer from Microsoft in 2008. If Yahoo had accepted Microsoft's bid, its shares may not have traded in the current $15 range with a market cap of $19 billion.

No wonder, shares rose over 5 percent in the pre-market hours. Shares of Yahoo have dropped 7 percent in the past year and 9 percent year-to-date and fallen steeply from the highs of $108 in December 1999.

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