Buyout rumors involving Microsoft and eBay are looking unlikely near-term.
Free cash flow is down 50% since 2005.
Growth opportunities in fee-based businesses contribute just 12% of revenue, and advertising seems likely to dry up in light of weak job and credit markets.
As I noted in my last column, I like to take a look at the stocks with unusual option activity on Stockpickr.com to see if there is anything sufficiently interesting to examine more closely. While I found a gem among deep out-of-the-money October calls in Motorola (MOT - commentary - Cramer's Take), further investigation of Yahoo! (YHOO - commentary - Cramer's Take) seems to indicate I may have bagged my limit.
Unlike Motorola, Yahoo! has no chance at a bloodletting, fire-the-CEO rally (justified or not) because it has already happened. Instead, any hopes for a short-term pop in Yahoo! shares are probably underpinned by the persistent buyout rumors, with Microsoft (MSFT - commentary - Cramer's Take) and eBay (EBAY - commentary - Cramer's Take) being the most frequently mentioned potential buyers. But the problem with those rumors is they have been around forever, and so far smoke has yet to signal fire. Anybody buying the name in hopes of a buyout should therefore be prepared (and paid) to wait.
So will Yahoo! reward a patient approach? It doesn't look that way to me. Its free cash flow in 2006 was $700 million, half the level achieved in 2005. It is only good for a 2.3% free cash flow yield on the current enterprise value. That means essentially all of the return potential has to come from growth -- which doesn't seem like a safe bet given last year's decline. Sure, the growth rate over the last five years is nearly 45% -- but that is coming off of the lowest lows of the Internet bust. The consensus five-year growth estimate is 24%, including a 20% decline in the current year.
By implication, that means the subsequent four years would have to post average growth of nearly 40% annually. Color me skeptical. With a return on equity of just 8.27%, assuming growth will be faster than that implies adding debt or issuing new shares unless they can somehow boost the ROE itself -- a feat far easier said than done. Coincidentally (or not), that is about in line with the actual year-over-year growth rate in the latest quarter.
At the time of publication, Trent had no positions in any of the stocks mentioned in this column, although positions may change at any time.William A. Trent, CFA, is a freelance equity analyst based in the New York metro area. He has been an equity analyst since 1996 and is co-author of Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Trent appreciates your feedback; click here to send him an email.
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