Alibaba Deal Should Jump Start Yahoo!

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I must admit, I was disappointed that Yahoo!’s (NASDAQ: YHOO) CEO Scott Thompson had to resign his post. He seemed to be well on his way to making meaningful changes at Yahoo!. However, I am impressed with the “go get em’” attitude of Daniel Loeb, the CEO of Third Point, which is Yahoo!’s largest shareholder. Within a week of him getting a seat on Yahoo!’s board of directors, the company signed off on a long-awaited, much-needed deal with Alibaba, which is considered one of Yahoo!’s most valued assets.

The deal gives Yahoo! the chance to monetize its most valuable assets, and take in billions of dollars upfront, which it desperately needs to help straighten out its finances. Zacks Investment Research points out that Yahoo! has lost almost 65% of its value since its 2006 peak. Since then, the company has struggled to improve its finances and build shareholder confidence.

The agreement with Alibaba addresses these issues by establishing a framework for Yahoo! to monetize its remaining interest in Alibaba in stages. Under the agreement, Alibaba will pay Yahoo! $6.3 billion in cash and up to $800 million in newly-issued preferred stock. Alibaba will have to repurchase up to 50% of Yahoo!'s stake, or about 20% of Alibaba's fully-diluted shares. The purchase price will be based on Alibaba’s valuation, which is estimated to be $35 billion.

If Alibaba IPOs like it is expected to do, it will have to buy back 25% of Yahoo's current stake. Its other option is to let Yahoo! sell those shares in the IPO.

Following an IPO, Yahoo! will have registration rights and rights to marketing support from Alibaba to help it get rid of its remaining shares.

I find these barometers to be very important because they give Yahoo! a level of control. In announcing that an agreement had been reached, Yahoo! noted that the staged exit that will take place over time balances near-term liquidity and return of cash to shareholders with the opportunity to participate in future value appreciation of Alibaba.

Like other observers of this deal, I am curious about whether or not Alibaba will be able to raise the money to cover the costs of this deal. However, Alibaba is very strong. It is a leader in China’s Internet market, with offerings similar to eBay. Bloomberg Businessweek reports that the company’s earning are so strong that Alibaba now accounts for a large portion of Yahoo!’s earnings. The news magazine found that Alibaba is now worth an estimated $35 billion, up from $2.5 billion seven years ago. Alibaba is considered one of the most successful companies in China’s growing Internet market. Alibaba also runs a search engine for shoppers and an online payment service.

Given that Yahoo!’s profits will decline as a result of Alibaba repurchasing the shares, I would like to see firm plans from Yahoo! about how it will deal with this loss. An idea being bandied about is for Yahoo! to buy back enough of shares under the expanded repurchase program in place to make up for any drop in earnings.

Also noteworthy about this agreement is Yahoo!’s intention to return just about all of the after-tax cash proceeds to shareholders after the transaction closes. It is finalizing the form of the return, and has increased Yahoo!'s share buyback authorization by $5 billion concurrently with this deal.

It’s unfortunate that it took so long for this deal to be completed, given the billions of dollars Yahoo! will receive upfront. I understand that the company was trying to get it done as a tax-free transaction, but that was simply too complicated.

It seems that it was only until Loeb and two other people from his company gained seats on Yahoo!’s board of directors that the deal was done. This was much to the delight of investors who saw Yahoo!’s shares flirt with $16 after the deal was officially announced on Monday, May 21. The increase, while small, was significant considering the stock has been stuck around $15 for the past two years. I thought the stock would sink, despite some valiant efforts that were being made to turn things around for the company that is one of the pioneers of the Internet search engine.

The Alibaba agreement follows the shake-up of the company’s board of directors and departure of CEO Scott Thompson. Loeb discovered that Thompson’s resume contained inaccurate information about his education and moved that the board fire him or that he resigned. Not only did he get his way on that, but he was also able to secure three board seats, including his own, at Yahoo!

The hedge fund owns some 70 million Yahoo! shares, or 5.8% of the company’s common stock.

I don’t see Yahoo! as an expensive stock, and it is still a turn around play. I think we will see an increase in its earnings as it implements cost reduction strategies. Also, I think the next major transaction for the company will be the monetization of Yahoo! Japan.

Yahoo!, like competitors Google (NASDAQ: GOOG) and Facebook (NASDAQ: FB) are under pressure to attract advertisers, especially as more consumers use mobile devices like smartphones and tablets instead of on desktop or even laptop computers.

I will be keeping an eye on a network agreement between Yahoo!, AOL and Microsoft that allows them “to sell each others unsold premium advertising inventory,” according to Reuters. Among the goals of the agreement is to increase margins and secure higher ad prices. The threesome is aiming to keep up with Google and Facebook, which surpassed Yahoo! earlier this year in display advertising.

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