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Does Alibaba IPO Help Yahoo?

NEW YORK (TheStreet) -- Since Yahoo!'s (YHOO) initial investment in Alibaba Group Holding in 2005, Alibaba has become the Wall Street darling and Yahoo its aging backer. At the time, Yahoo, which traded mid-day at $39.40, paid a meager $1 billion for a 40% stake in the Chinese upstart, hoping to gain exposure to the blossoming Chinese consumer market.

These days, Alibaba is expected to raise up to $15 billion in its initial public offering, and begin trading on a U.S. exchange this fall. 

The IPP would value the Chinese e-commerce giant at around $140 billion. The valuation makes it one of the most anticipated offerings in the technology sector since Facebook's (FB) IPO last June, which raised $16 billion and at the time and valued the company at more than $100 billion.

Alibaba's business model is a mixture of eBay (EBAY) and Amazon.com  (AMZN), but with a slight twist. The e-commerce company has always acted as a middleman, unlike Amazon which holds inventory, connects buyers and sellers and facilitates transactions between them. It also is similar to eBay due to its role as a middleman, although it is not an auction-based platform.

While the company is similar to the two U.S. online retail giants, Alibaba's platform handles more goods than both companies combined.

Alibaba's revenues are not spectacular at $1.78 billion, because it does not physically sell any products. Its profitability, however, at $792 million gives the company a 44.6% margin of profit according to Yahoo. This is in stark contrast to companies such as Amazon that fail to make any profit at all on much larger revenues.

The current breakdown of Alibaba's ownership is Yahoo (24% ownership), Japan's Softbank (OTC: SFTBY) (37% ownership), and Alibaba's founders and some senior managers (13% ownership).

Yahoo's portion could be worth up to $37 billion according to analysts. This comes after Yahoo sold shares back to Alibaba in 2012 to raise cash, earning $4.6 billion for giving up 16% ownership, paltry numbers compared to what the shares would be worth now.

Kenneth Goldman, Yahoo's chief financial officer, recently told investors that Yahoo would have to sell 10% of its Alibaba holdings due to the offering. The terms of agreement would force Yahoo to sell a significant portion of its holdings at the underwriter's price, missing out on the expected boost it would see on the first day of trading. YHOO Chart
YHOO data by YCharts

Both Alibaba and Yahoo stand to raise a large amount of cash over the next few months due to the offering, but the next step is to generate profits for their core-businesses with the excess funds.

Alibaba's model is self-sustaining and continues to outperform its larger competitors, but Yahoo, with a large number of acquisitions already, has failed to convert cash into revenue. Yahoo saw revenue decline from more than $7 billion in 2008, to 4,68 bill this past year. In the Marissa Mayer era Yahoo lost display ad revenue. The core display ad revenue decreased by 6% this past year. 

The cash from the Alibaba offering would give the Yahoo more flexibility, but until its core-business picks up, it is hard to be overly bullish on the company.

At the time of publication, the author had no position in any of the funds mentioned.

Follow @macroinsights

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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