Yahoo! Japan Key to YHOO Treasure

NEW YORK (TheStreet) -- Yahoo!'s (YHOO) earnings on Monday garnered a lot of attention because of the star power of new CEO Marissa Mayer and a focus by most analysts and journalists on the state of the comeback of the Yahoo!'s core business.

What didn't get a lot of attention was Yahoo! Japan. It should have.

Yahoo! Japan is the leading Japanese portal and a huge e-commerce player. It's jointly owned by Yahoo! and Softbank - the new owner of Spring ( S). Yahoo's stake in Yahoo! Japan is 35%.

When it comes to Yahoo!'s "Asian assets," most Americans think only about Alibaba. There's good reason. Alibaba will probably be worth $60 billion when it IPOs (as early as this year perhaps). But YJ isn't chopped liver.

YJ is actually worth more than Yahoo!: $24 billion vs. $23.3 billion. Surprised?That's thanks to Tuesday night's trading, which sent YJ up on the news of a great quarter.

A year ago, you might remember that then new Yahoo! CEO Scott Thompson was trying to unload the stake in YJ. He and CFO Tim Morse telegraphed a couple of times on their earnings call that they were actively trying to sell their stake in YJ. However, later in the year, they sheepishly admitted that the valuation gap between the two sides was too big and a deal couldn't be completed.

Thank goodness Yahoo! shareholders were able to avoid that fate. A year ago, Yahoo! Japan's shares traded in Tokyo for JPY23,000 per share.

Wednesday morning, Yahoo! Japan's shares (4689: Tokyo) are trading for JPY37,000 per share.

What happened?

Yahoo! Japan has a new and younger management team in place who have been doing a great job in their first couple of quarters. Tuesday, they released their financial results and they demonstrated an acceleration in growth at the company and the best financial results since 2007.Here's a taste:
  • Revenue up 16% vs. a year ago
  • Operating income up 20%
  • Ordinary income up 18%
  • Quarterly net income up 22%

    But the big news was that the company announced a very large stock buyback: 6% of the float or 25% of the average volume when they'll be making the purchases on the open market.

    The company pointed out that all these shares will be retired. Why? Because suddenly earnings per share will increase significantly.

    So the good news for Yahoo! shareholders is that their stake in YJ is worth $8.2 billion today vs. $5 billion a year ago. Net of taxes and fees, that YJ stake is worth $5.07 per Yahoo! share vs. $2.83 per share a year ago.

    So why would YJ want to do a deal now with Yahoo! for their 35% stake? Well, I'm sure if they had their druthers, they would have loved to do a deal with Scott Thompson at that discounted price. But even paying off Yahoo! at current prices, YJ would be crazy not to do it.

    Just today, YJ's stock was up 15% on good earnings and news of a planned stock buyback to retire 6% of their float. What would it do on news that YJ was going to retire another 35% of their shares -- the equivalent of 244x the daily volume of shares traded? It's worth it to YJ to do a deal with Yahoo!.

    What would Yahoo! do with another $5.5 billion of cash net of taxes and fees? Probably buy back a lot of shares.

    Yahoo! just retired almost 7% of their shares outstanding in the last quarter for a price of $1.5 billion. They will probably be spending another $1.5 billion this quarter on stock buybacks which -- at say an average cost of $22/share -- would retire another 68 million shares or 6.2% of the shares outstanding.

    If a YJ deal happens this year and Yahoo! earmarks $4 billion of the $5.5 billion due to it for buybacks, you are talking about another 150 million shares that could be retired within a year from now (assuming a $26/share average cost). The share count would drop from 1.2 billion as of the end of Q3 to 850 million in a year from now.

    At the moment, the analyst consensus on Yahoo! is that it will do $1.27 in EPS in 2014. They're using the old 1.2 billion share count number for that.

    Let's assume that Yahoo! can actually show some double-digit revenue and earnings growth next year and do a YJ-type 22% growth in net income. That's $1.55 in EPS at the old share count or $1.86 billion in earnings.

    On an 850 million share count, that $1.86 billion in earnings becomes $2.19 in EPS or almost double the current estimate.

    At a 10x multiple of $1.86 billion in earnings, Yahoo! would be worth nearly $11 billion.At the moment, net of its Alibaba stake (at a $60 billion valuation and post taxes), its YJ stake, and its cash, Yahoo!'s core business is being valued at $1.43 billion.

    Yahoo!'s stake in YJ is nothing to sniff at. And it might be a key catalyst for Yahoo this year.

    At the time of publication, the author was long YHOO.

    This article was written by an independent contributor, separate from TheStreet's regular news coverage.

    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 eric.jackson@thestreet.com.

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