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.

My guess is that Alibaba's valuation for its IPO -- assuming it's this year -- will probably come in between $65 million to $70 billion, so Alibaba will have excess left on this new debt it's raising.

Most Yahoo! watchers expect an extra billion to Yahoo! for the preferred shares. That plus the confirmation that Alibaba is going to go public could really put a bounce in Yahoo!'s stock.

At the time of publication, Jackson was long YHOO.

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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