Should Investors Follow Dan Loeb Out of Yahoo!?

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Monday wasn't a good day for Yahoo! (NASDAQ: YHOO) shareholders. The company announced that three of its directors were resigning, and that Dan Loeb’s Third Point was selling most of its stake.

Loeb’s work with Yahoo! was certainly impressive, and having made his money, he’s probably moving on to new fights (a bigger Sony stake?). But with Third Point out of the picture, the Yahoo! story may have just fundamentally changed.

Yahoo!’s Alibaba-fueled rally

Since Sept. 2011 (when Third Point began accumulating a stake) shares are up well over 115%. Yahoo!’s new CEO, Marissa Mayer, may get a lot of credit for the turnaround, but for the most part, the Yahoo! story has been all about something it did in 2005. Back then, the company invested in Alibaba, a Chinese Internet retailer that now does more business than Amazon and eBay combined.

Last September, Yahoo! sold about half of its Alibaba stake, raising over $4 billion in the process. Of that, $3 billion was dedicated to buying back stock, while just over $1 billion was put towards acquisitions.

Yahoo! still owns over 20% of Alibaba, and when the company goes public, Yahoo! will get another cash windfall.

Buybacks vs acquisitions

But what Yahoo! does with that money is key. If Loeb was still heavily involved, it might have been mostly distributed to shareholders. But if he’s out of the picture, it will probably be put towards buying more companies.

About a week after Loeb joined Yahoo!’s board, the company announced that it would be selling about half of its Alibaba stake and returning “substantially all” of that to shareholders.

Then Mayer was hired. And in August, Mayer was said to be considering keeping the Alibaba money, and using it solely for acquisitions. Shareholders didn't like that -- the stock tumbled 5%. Ultimately, a deal was struck wherein Yahoo! returned about $3 billion to shareholders via a buyback, and just over a billion was kept for the purpose of acquisitions.

A Reuters report, citing unnamed sources, claimed that Loeb supported Mayer’s decision to consider acquisitions instead of a buyback. But I’m skeptical.

Yahoo!’s Alibaba stake was Loeb’s key focus in his original presentation. He called it a “promising, overlooked asset” and said it was worth $5.24 per Yahoo! share. In contrast, Loeb derided the core Yahoo! business for stealing the spotlight, and offered only vague suggestions for its improvement (become a “social gaming host” or “video aggregation platform”).

Now that Loeb is selling the bulk of his stake, less than two years after buying in, it seems pretty clear that his Yahoo! investment was a cash grab.

Yahoo!’s core business shows promise, but continues to struggle

Of course, returning cash to shareholders is probably the best way to unlock Yahoo!’s value in the short-run.

Although Yahoo! shares surged after the company reported earnings earlier in July, core Yahoo! didn't have much to do with it. Mayer may have turned around the company’s culture and changed its image, but it hasn't translated into meaningful financial improvement just yet.

Yahoo!’s ad prices fell by 12% in the second quarter as its share of the search engine market declined. The company cut revenue guidance for the year. As BGC analyst Colin Gillis noted, “the hard work is still ahead” and core Yahoo! is still “struggling.” That said, Mayer has had only a year on the job, and corporate turnarounds take time.

Already, under her leadership, Yahoo! has revamped its webmail, updated its news feed, and redesigned Flickr. Tumblr could form the basis of Yahoo!'s social strategy, but it hasn't yet been fully integrated into the Yahoo! family. At the same time, Yahoo! has been buying up dozens of small companies in the hopes of strengthening its workforce.

These initiatives are likely what's best for Yahoo! (and therefore its shareholders) in the long-run.

What could Yahoo! acquire?

But despite all the companies Yahoo! has bought recently, the shopping spree may not yet be over. And if Yahoo! is about to get billions from Alibaba’s IPO, there’s a lot that it could afford.

Non-publicly traded companies like Vimeo, Pinterest, Twitter or Foursquare might be most likely, but there are some publicly traded companies that could be considered.

Yelp (NYSE: YELP) has seen its shares surge on Yahoo! takeover rumors in the past, and it could give the company a foothold into the growing local market. Yahoo! used to be a big player in this market (Yahoo! Local was big decade ago), but Yelp has come to dominate the space in recent years.

Still, I’m skeptical of a Yahoo! bid for Yelp. Mayer has said she has no interest in mapping, and Yelp’s value might be best as part of a maps application. Google purchased Yelp’s rival Zagat and integrated it into Google Maps. Thus, it would more sense for Apple to buy Yelp for its own maps app, then it would for Yahoo! to buy the company.

Rumors have also linked Yahoo! to OpenTable (NASDAQ: OPEN). Analysts at Wunderlich speculated as much, writing in March that a deal could make sense.

But as with Yelp, it’s hard to envision OpenTable’s strategic value to Yahoo!. The $1.45 billion online restaurant reservation company is profitable and dominates its industry, but seems like too much of a niche for a large Internet platform like Yahoo!.

That said, there might be reasons to own OpenTable apart from a potential takeover. The stock does carry a high short float percentage -- nearly 20% -- which could result in some potent short squeezes.

Investing in Yahoo!

With Loeb scaling out of Yahoo!, the investment story may have completely changed. The company’s recent rally has been prompted largely by a share repurchase program. That program was the result of Yahoo!’s decision to sell half its Alibaba stake.

Yahoo! will receive another large chunk of cash sometime in the near future. When Alibaba goes public, Yahoo! could bring in billions.

But what the company does with the money is key. When Loeb was on the board, investors may have been confident that they would be getting the cash returned to them directly. With Loeb gone, it’s not as clear. Instead, that money could be used for acquisitions.

And if that’s the case, it will completely change the Yahoo! story. Until now, Yahoo! has been a capital return story; going forward, it will be all about Mayer's plan to revitalize Yahoo!.

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Joe Kurtz has no position in any stocks mentioned. The Motley Fool recommends OpenTable. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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