NEW YORK (TheStreet) -- I have had a love-hate relationship with Yahoo! (YHOO) for five years now. I have always thought the stock was undervalued and primed for a turnaround that could unlock value. That's why I longed the stock and led an activist campaign against it. Unfortunately, even though the campaign resulted in former CEO Terry Semel quitting in 2007, the company's board muffed the chance to sign a deal with Microsoft (MSFT) - Get Microsoft Corporation Report leading to the company's stock price to collapse. It's really never recovered.
Yahoo!'s new CEO is into her third year at the helm of the Internet company. Most investors and analysts are fixated on her efforts to turn the business around. When you listen to the earnings calls, 95% of the discussion from Carol Bartz and her CFO, Tim Morse, focuses on the wholly-owned business.
Yet, despite the company finally biting the bullet and doing needed layoffs and closing underperforming or overlapping businesses -- things that have been obvious to many for years -- my interest in Yahoo! is purely based on its private stake in
, the parent company of Alibaba.com, Taobao and Alipay.
There has been some general talk among investors who don't follow Yahoo! closely that Yahoo! should "monetize" the Asian assets. By this, I think they are suggesting that Yahoo! divest its stake in Yahoo! Japan and Alibaba Group. There also seems to be a lot of hope that private equity will come in and buy the wholly-owned company. Remember the spike-up in shares we saw a few months ago when rumors circulated that
was going to team up with private equity to make a bid for Yahoo!?
To me, all the private equity talk and concern about the current or future health of the Yahoo! core business is a side-show. I believe most of Yahoo!'s largest shareholders believe -- as I do -- that the real value-creation in Yahoo! shares will come when the market sees how big Taobao and Alipay are going to be in the next 10 years.
Let's do a sum-of-the-parts on Yahoo!
Tim Morse discussed last week that they are looking into a tax-free spin-off of their Yahoo! Japan stake. At recent market prices, Yahoo!'s 35% stake in Yahoo! Japan is worth $5.76 per share.
At the end of last quarter, Yahoo!'s cash and deferred revenue amounted to $2.96 per share.
Its 29% stake in Alibaba.com is currently worth $2.9 billion or $2.21 per share. That's actually 9% higher than what it was worth at the end of December, even after the news over the weekend that Alibaba.com's CEO and CFO were stepping down due to some small cases of fraud, which were found on the B2B site recently. That news dropped Alibaba.com's stock by 8% on Monday in Hong Kong, and carried over to impacting on Yahoo!'s stock price on Tuesday. But, even with that drop, Alibaba.com's stock only retraced to late January levels.
What is Yahoo's core business worth? If you take the mid-range of next year's earnings per share (of 91 cents) and apply a below market multiple of 7x, you come to a per share valuation for the wholly-owned business of $6.37. That's roughly half the forward valuation for the S&P 500 at the moment.
You add all these numbers up and you get to a per share valuation of $17.30 and we haven't counted anything for the Asian private assets yet.
There are differing views about what Taobao and Alipay are worth because they are private. Some analysts covering Yahoo!, value these private stakes for little more than what Alibaba.com is worth ($2.5 billion). Others put it at around $10 billion. Most analysts also take off 10% of the stake's worth as a liquidity discount and 30% as a tax discount.
The bottom line is that both Taobao (which could be best described as a combination of
of China, with close to a 90% market share) and Alipay (which is the dominant e-payments processor in China) are massive companies with an even brighter future.
recently projected that the e-commerce market (including payments) in China would increase five-fold in the next four years.
Reports in the local Chinese press have estimated that Taobao's annual revenue alone is now almost $1 billion and is profitable. Alipay's revenues are also believed to be large with more than a 50% market share of the payments market currently in China, although some speculate it is not yet profitable for Alibaba Group. We do know that PayPal will surpass eBay's Marketplace business in size within the next three to five years, according to that company's recent analyst day presentation.
Marianne Wolk of
has done the best analysis I've seen on the potential value to Yahoo! of the Taobao and Alipay stakes. She's also estimated that Taobao did between $825 million and $1.2 billion in revenue last year. Based on a lowball estimate of future growth, Wolk believes Taobao's revenues will reach $2.5 billion by 2012. In an optimistic scenario, she thinks the site could hit $7.35 billion in revenues by then.
What would Taobao be worth in an IPO? There have been two popular recent Chinese IPOs: high-flier online video site
and a much smaller competitor to Taobao called
At current prices, Dangdang sports an Enterprise Value to Forward Revenue multiple of 2.4x (Wolk estimates DANG will do $800 million in revenues by then). Youku trades at a higher multiple of 21x (with her assuming they will do $170 million in revenues by then).
It's likely that a Taobao IPO would fall in-between Dangdang and Youku from a multiple perspective. But a mid-range multiple of 10x, along with a mid-range estimate of 2012 Taobao revenues of $5 billion gives a current valuation of at least $50 billion. Some I've spoken to within China believe that, a Taobao IPO within the next 12 months could lead to a valuation closer to $100 billion based on market excitement over the dramatic coming penetration of the Internet in China over the next five years, increased standard of living of shoppers, and Taobao's dominant market position.
Assuming a current $50 billion valuation for Taobao alone (and assuming Alipay is worth half of that), Yahoo!'s 40% stake in the private Alibaba entities is worth $30 billion today (representing $22.90 per share). Even if you take a 40% haircut on that for taxes and illiquidity, that's $18 billion of value or $13.74 per share for these private stakes.
This brings a total sum-of-the-parts valuation of Yahoo! to $31.04 per share.
Why then is the market pricing Yahoo! at nearly half that valuation? I think it's simply a case of U.S.-centric investors and analysts not being aware of what's going on with private Taobao and Alipay. Of course, Carol Bartz doesn't discuss this inherent value that's being created because she has no part in it. By Tim Morse's own admission last week, Yahoo! is purely a financial investor in Alibaba Group. It provides no operational insight.
So, despite the chorus of Yahoo! critics who say the stock has been "dead money" for years, there is good reason to believe there will be a dramatic re-pricing of Yahoo!'s stock in the next couple of years.
While I think it would be foolish for Yahoo! to sell its entire 40% stake in Alibaba Group anytime soon, there would be some merit to selling a portion of it back to Alibaba Group management. At the moment, Yahoo! owns 40% of Alibaba Group, while Softbank owns 30%. Alibaba Group management only owns 30%.
There is no indication that there will be an Alipay or Taobao IPO anytime soon, according to the latest public comments. If I were Alibaba management, I would like more "skin in the game" before an IPO. Carol Bartz also has an incentive to see an IPO happen.
According to her employment contract, she can maximize her wealth, if she can get Yahoo!'s stock price above $35.19 for 20 straight trading days by the end of 2012. A hot Taobao IPO would make that possible.
Now, almost no one assumes it is possible for Yahoo! to ever get its stock higher than the old Microsoft offer for the company in 2008. But, on a sum-of-the-parts basis, I believe that is a very realistic goal between now and the end of 2012. And I like it that Bartz has a big incentive to make something happen. If she and Softbank decided to do a deal with Alibaba management, it could work out to be a beautiful win-win-win.
In the meantime, I'm happy to patiently wait, owning an asset worth $1 that is trading for 55 cents.
Eric Jackson held a long position in YHOO at the time of publication.
Eric Jackson is founder and Managing Member of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. In January 2007, Jackson started the world's first Internet-based campaign to increase shareholder value at Yahoo!, leading to a change in CEOs in 2007. He also spoke out in favor of Yahoo!'s accepting Microsoft's buyout offer in 2008. Global Proxy Watch named Jackson as one of its 10 "Stars" who positively influenced international corporate governance and shareowner value in 2007.
Prior to founding Ironfire Capital, Jackson was President and CEO of Jackson Leadership Systems, Inc., a leadership, strategy, and governance consulting firm. He completed his Ph.D. in the Management Department at the Columbia University Graduate School of Business in New York, with a specialization in Strategic Management and Corporate Governance, and holds a B.A. from McGill University.
He was previously Vice President of Strategy and Business Development at VoiceGenie Technologies, a software firm now owned by Alcatel-Lucent. In 2004, Jackson founded the Young Patrons' Circle at the Royal Ontario Museum in Toronto, which is now the second-largest social and philanthropic group of its kind in North America, raising $500,000 annually for the museum. You can follow Jackson on Twitter at www.twitter.com/ericjackson or @ericjackson.
You can contact Eric by emailing him at email@example.com.