Topic: Growth Stocks

Yahoo sells for little more than the value of its 24% stake in Alibaba, the Chinese “”

Tech StocksPat McKeough responds to many requests from members of his Inner Circle for advice on specific stocks, as well as questions on investment strategy and the economy. Every week, his comments and recommendations on the most intriguing questions of the past week go out to all Inner Circle members. And each week we offer you a report on one of the stocks profiled in these Q&A sessions. We give you Pat’s buy-hold-sell recommendation as well as his analysis of the stock. This is part of our new approach offering you regular and specific buy, hold and sell advice in our daily posts. Every week you’ll get “A Stock to Sell” on Monday, “Best Canadian Stocks” on Tuesday, and “Our Top U.S. Stocks” on Thursday.

This week an Inner Circle member asked us about one of the top tech stocks competing for market share in online search and content. Two years ago, Yahoo hired a new president and CEO away from rival Google to help the company make up lost ground against Google and Facebook. Pat examines the measures Marissa Mayer has taken to improve Yahoo’s competitive position. He also discusses Yahoo’s big stake in Alibaba, the Chinese “”, and the impact that company’s upcoming IPO will have on Yahoo’s prospects.

Q: I would like your evaluation on the prospects for Yahoo. Thank you.

A: Yahoo! Inc. (symbol YHOO on Nasdaq;, offered one of the Internet’s first search engines when it launched in 1994 and has since become one of the most popular online destinations for content. Its sites also have a range of other features, including shopping and email.

In July 2012, Yahoo appointed Marissa Mayer as president and CEO. Mayer joined Google in 1999 and helped develop many of that company’s most popular services. She was a vice-president at Google before she left.

Under Mayer, Yahoo is simplifying the design of its websites, which should draw more users and help the company compete with Google and Facebook. In addition, Yahoo is shutting down many of its less-popular services to focus on its main sites. The company plans to cut the number of websites it operates from over 50 to around 10.

At the same time, the company is working on making its services more popular among mobile device users. Recently launched mobile products include Yahoo News Digest for Android and a new version of Yahoo Mail for iPhone and Android.

The company is also developing exclusive online TV programming. For example, it recently teamed up with Sony Pictures to produce 13 new episodes of Community, a sitcom that NBC recently cancelled. Yahoo feels exclusive content like this will help it compete with Google’s YouTube video service and online movie and TV provider Netflix.

However, Yahoo continues to face strong competition from other search engines. In the three months ended June 30, 2014, its revenue fell 4.5%, to $1.08 billion from $1.14 billion a year earlier. If you exclude payments to affiliated websites that direct traffic to Yahoo’s sites, revenue declined 2.9%.

Yahoo could earn $10 billion in sale of Alibaba shares following Chinese group’s IPO

Yahoo charges advertisers every time a user clicks on one of their ads, and the number of paid clicks rose 3% in the latest quarter, while the average cost advertisers paid per click gained 15%. The company also sells display ads on its websites. The number of display ads rose 24%, but the price per ad fell 24%.
Before one-time items, earnings fell 1.1%, to $381.7 million from $385.9 million. Yahoo spent $719 million on share repurchases in the latest quarter. As a result, earnings per share rose 5.7%, to $0.37 from $0.35. The company spends a high 25% of its revenue on product development.

Yahoo’s balance sheet is sound: as of March 31, 2014, its long-term debt was $1.1 billion, or a low 3.0% of its market cap. It also held cash and investments of $4.3 billion, or $4.30 a share.

The stock has moved up 28% in the past year, partly because Yahoo owns 24% of China’s Alibaba Group, which provides search, shopping, payment and cloud computing services.

Alibaba recently announced that it will sell shares in an initial public offering (IPO). It will probably complete the sale in August 2014, and the stock will trade on New York under the BABA symbol.

In the run-up to its IPO, Alibaba has valued itself at about $130 billion, which means Yahoo’s 24% stake is worth about $31.2 billon. That’s almost equal to Yahoo’s market cap of $36.1 billion—so the company is essentially trading for the value of its Alibaba holding.

What’s more, Yahoo owns a 35% stake in publicly traded Yahoo Japan. This holding is valued at around $11 billion.

There is some uncertainty about the final value of Alibaba and the actual value of Yahoo Japan if Yahoo were to sell its entire interest. But Yahoo is profitable—it trades at 22.3 times this year’s projected earnings of $1.61 a share—and after the Alibaba IPO, it plans to sell about 27%, or 140 million, of its Alibaba shares. That could raise around $10 billion for the company.

This will give Yahoo a big cash balance for acquisitions, special dividends or share buybacks. Meanwhile, you get all of Yahoo’s operations for essentially nothing above the value of its Alibaba holding. That adds to the stock’s appeal.

We view Yahoo as an attractive hold, but only for aggressive investors.

On Monday, we will tell you about a Canadian stock that’s a sell.

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