Yahoo: Throwing in the Towel?

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Yahoo: Throwing in the Towel? - Brian Wieser, Pivotal Research Group

BOTTOM LINE: The Wall Street Journal has reported that Yahoo's Board "is expected to discuss whether to proceed with a plan to spin off (its Alibaba stake), find a buyer for Yahoo's core business...or both." This follows the delivery of a letter from investor Starboard Value expressing a preference that Yahoo pursue a sale of the core business two weeks ago. We would similarly view a sale in a positive light if one could be realized.

The potential for Yahoo selling its core business is now likely to receive more attention from investors following efforts from activists and a new report in the Wall Street Journal that Yahoo's board is considering this possibility. Realizing value is far from assured, however. Yahoo's core business is in seemingly permanent decline on a like-for-like basis, with growth salvaged over the long-run (in our model) by the use of free cash flow to buy revenue through acquisitions. As it stands, Yahoo can remain a large player in search without external acquisitions, but anything other than #1 may be a weak position. Growth will not necessarily match industry levels because there are real efficiencies in concentrating search budgets with Google. As well, most small advertisers will only buy search from one provider, concentrating budgets with Google alone. Further, there is a risk that other companies – such as Facebook – establish their own search business and quickly take share of the market. And then there is the shifting nature of the market of paid search advertising, where the dominant spenders (both small businesses and e-commerce advertisers alike) are increasingly flexible as to whether or not they are buying search or non-search inventory.

Meanwhile, in display, Yahoo suffers because like-for-like display advertising has faced and will continue to face deflationary conditions. Yahoo is hit hard because it historically was able to generate high pricing for its inventory. This was true because Yahoo offered (and still offers) relatively good targeting and efficiently aggregated audiences. However, in a programmatic era, efficient audience aggregation is not unique to Yahoo. To some degree Yahoo can retain "share of wallet" by adding more video inventory to its mix of ad units (as video units typically command higher prices vs. display) but this opportunity may be limited as every other publisher adds more and more video inventory to their properties. Otherwise, ongoing investment in content may help, but strategic and executional choices probably need to be changed and / or improved.

The saving grace for Yahoo is that it still has a relatively large user base that is reliant on the platform so long as they maintain email addresses there. It also has a still-relatively strong (and still-relatively large) sales force. As long as both of those factors remain in place, there would be time for an acquirer to establish new strategies and develop products while the property continues to generate cash flow. These elements provide support for a range of potential acquirers, who could come from the telco world (as we saw with Verizon buying AOL), the data/marketing services world (as we saw with ADS buying Conversant) or from more traditional internet and media sub-sectors. The big question is whether anyone would actually show up with a meaningful bid. We can understand why a buyer looking to attach their existing assets to a large media property might look at Yahoo only reluctantly vs. alternative strategies. We can also imagine that there would be private equity buyers – or individuals with private equity backing and different ideas as to how to turn the business around (or different executional capabilities) – who would come up with realistic bids if strategic buyers did not.

Overall, we place a value on Yahoo's core business of $1.9bn, not counting the $5.8bn in cash we expect Yahoo to have on its balance sheet at year-end 2016, including an assumption of mid-single digit top-line growth and stable mid-30s adjusted EBITDA margins post 2016 supported by $1bn in annual capex and M&A. We assume only 2% long-term growth (the lowest among companies we cover) and a 15% long-term discount rate (the highest among companies we cover). Of course, there are a range of other scenarios that might be as plausible, such as lower margins and lower growth (or decline) but less M&A that produces the same valuation. Whatever the right assumptions, the low absolute price we assign to the business suggests that a sale process would have a high probability of causing core Yahoo to produce higher value for shareholders than it presently does today.

VALUATION: We value Yahoo with its core business worth $3/share and cash less debt worth nearly $5. We value the Alibaba and Yahoo Japan assets at $29/share presently.

RISKS: 1) Ongoing erosion in the core business 2) Unfavorable outcome from monetizing stakes in Alibaba and Yahoo Japan and 3) Uncertainty about new management.


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