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Alibaba Throws Money at Yahoo!

This post originally appeared on May 3, 2013 on Real Money. To read more content like this + see inside Jim Cramer's multi-million dollar portfolio for FREE. Click Here NOW.

There was news overnight that Chinese e-commerce site Alibaba Group has secured up to $9 billion in debt financing from nine different banks. According Bloomberg, the purpose of the new debt is to refinance other debt to pay Yahoo! (YHOO) for its preferred shares and for general corporate purposes. To me, this new debt is all about paying Yahoo!

It's true that Alibaba wants to buy back preferred shares the Internet pioneer owns in Alibaba. This has largely been ignored by most Yahoo! watchers, but it could lead to another $1 billion (pretax) for additional Yahoo! stock buybacks.

Last year when Alibaba bought back the first tranche of Yahoo! shares, it needed debt financing. Yahoo! decided to help finance this buyback to the tune of $800 million. Many other banks also kicked in money. In exchange for the $800 million, Yahoo! got back "preferred shares" in Alibaba that pay 10% a year in interest (with 30% of that in cash and the balance in additional preferred shares that get tacked on to the $800 million which Yahoo! is owed).

As of today, the amount Yahoo! is owed for the preferred shares is about $835 million. The shares can never be turned into Alibaba equity. They can simply be retired by being paid back or accumulate interest. It's in Alibaba's interest to extinguish them as quickly as possible. Alibaba will certainly do this before its initial public offering, which could happen in the second half of this year.

At that time, Alibaba could (and almost certainly would) buy back half of Yahoo!'s remaining 24% stake. The price it pays would be the IPO price set by the market. Then either Alibaba could buy Yahoo!'s shares or market investors could. Of course, be Alibaba would buy them; for that, it needs to tap its credit lines.

If Alibaba used its $9 billion credit line to pay back Yahoo! for its 12% stake, that would imply a maximum $75 billion valuation for Alibaba. But don't forget that Alibaba also has other debt it's previously arranged that it might use for the nearly $1 billion needed to pay back Yahoo! for the preferred shares and if Alibaba's valuation goes higher than $75 billion.

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