Yahoo!: Perils of Whale Watching

NEW YORK (TheStreet) -- Earlier this spring, when Yahoo!(YHOO) was bumping along around $16 a share, David Einhorn bought the stock.

When he revealed the new holding on May 2, the stock jumped. A few days later, it closed at $18.65 a share. Investors were finally ready to buy in to the Yahoo! sum-of-the-parts story which suggested the stock was worth in the mid- to high-$20s.

According to Einhorn's first quarter letter:

"The Partnerships established a new position in Yahoo! at an average cost of $16.93 per share. The company developed an extraordinary anti-shareholder reputation in recent years, beginning with its ill-advised decision in early 2008 to turn down Microsoft's(MSFT) equally ill-advised (and ill-timed) bid to buy the company for $31 per share.

"Now, under new management, YHOO has taken some increasingly shareholder-friendly steps. It has given up competing with Google(GOOG) in the web search business, a move which is improving free cash flow by reducing capex and operating expenses. It is using the improved cash flow to step up share repurchases (the company bought back more than 7% of its outstanding shares in 2010). YHOO is also taking steps to unlock value from some of its Asian assets in a tax efficient manner, including its 35% stake in publicly-traded Yahoo Japan.

"YHOO currently has $3 per share of net cash on its balance sheet and has approximately another $8 per share of value in its two minority equity stakes of publicly traded companies in Asia (Yahoo Japan and Alibaba.com). Assigning a conservative valuation (5x current year EBITDA) implies $18 per share for just the core businesses and the publicly traded securities and cash.

"We believe that Yahoo's most valuable asset is its 40% stake in Alibaba Group's still-private holdings, which are separate and distinct from its ownership in the publicly-traded Alibaba.com, which we are essentially getting for free. Among Alibaba Group's privately held Chinese internet assets is a company called Taobao, which is the leading eCommerce website in China. More merchandise was sold on Taobao last year than on eBay, and Taobao's merchandise sales are growing 100% annually. We would not be surprised if YHOO's 40% stake in Alibaba Group alone was ultimately worth YHOO's entire current market value. YHOO stock ended the quarter at $16.68 per share."