Updated from 12:08 P.M. to include facts about declining EBITDA, total headcount, and slowing revenue growth.
NEW YORK (TheStreet) -- Over the last two weeks, I have spoken out in favor of Yahoo! (YHOO) accepting a buyout offer from either Alibaba or SoftBank, as well as why I believe Marissa Mayer must not stand in the way of such a transaction even though it's against her own self-interest.
I have laid out the self-inflicted mistakes I perceive she has made over the course of her tenure as CEO:
- Hiring and firing Henrique De Castro as COO and head of sales.
- Instead of laying off excess employees, she has increased headcount at Yahoo!. At the end of the second quarter, Yahoo!'s total headcount increased 5% versus the prior year to approximately 12,200 employees.
- None of the $2 billion in acquisitions she has made to date are reflected in the value ascribed by investors to the core business, which suggests she will continue to make value-destroying acquisitions after receiving the Alibaba IPO stake sale cash. Second quarter revenue came in at $1.084 billion, down from $1.135 billion in second quarter of 2013.
- The fact that she has hyped mobile user growth for Yahoo!, even though it would have happened anyway given the secular move of desktop users to mobile, and she likely doesn't discuss mobile monetization because it's very poor. On the second quarter earnings call, CFO Ken Goldman said Yahoo! has "given the exact percentage" of how much revenue comes from mobile, but did note "it is meaningful."
- She has rewarded herself and her management team with excessive stock compensation in the facing of declining earnings before interest, taxes, depreciation and amortization (EBITDA). During the quarter, the company recognized $340 million in Adjusted EBITDA, down from $369 million in the second quarter of 2013, despite monetizing a portion of the company's patent portfolio.
Longtime Yahoo! shareholders like me suffered for years under poor management and board neglect. Though it's been heartening to watch the stock price increase from $11 in 2011 (pre-Marissa) to now $35, it's obvious to all that this is almost entirely due to the increase in value of Alibaba from $20 billion in 2011 to what many think will be $200 billion post-IPO.
Once you look at the current price and tease out all the components, investors either believe the core business (Search and Display) is worth nothing (when it has twice the EBITDA of AOL (AOL), which has a $3.1 billion valuation) or they are assuming any cash Yahoo! has and will soon get will be wasted on value-destroying acquisitions which will transfer the Alibaba cash to venture capitalists and entrepreneurs instead of returning it to Yahoo! shareholders.
Yet, as I've made the case for already, if either Alibaba or SoftBank were to acquire Yahoo!, they could pay up to $20 billion more for Yahoo! and -- thanks to tax savings of reacquiring their own stakes -- still effectively pay the same price as any other potential buyer of Yahoo! at the current price.
So, in my view, Yahoo! shareholders would be better off seeing either of these two company pay more for Yahoo! now before Marissa Mayer can spend the incoming Alibaba cash on poor acquisitions. All Yahoo! stakeholders -- shareholders, Alibaba, SoftBank, regulators, users -- would be better off with such an outcome except for Marissa Mayer and her management team, as there is a good chance the CEO would be replaced and then other dominoes on the management team might start falling.
If Mayer has a plan to get the stock to $45 and higher, I'm sure Yahoo! shareholders would love to hear it. However, I think the plan they would hear would be something like what they've already heard:
- Daily habits
- I've always said this turnaround would take years.
- We now get lots of resumes from people who want to work here.
- Things were really bad before.
- It's better that we now have 450 million mobile users instead of 200 million.
- We will continue to be good stewards of capital.
I believe that such a recitation -- absent Yahoo! shareholders speaking out for change - would immediately send the stock back down to $32, where it was before I started discussing publicly the potential value which could be created from Alibaba or SoftBank buying Yahoo!.
Yahoo!'s core business was never going to be an easy fix for any CEO starting in 2012 when Mayer arrived. There have been some Mayer defenders who have said that short-sighted investors like me are pushing for change when all that Mayer needs is more time.
To that, I'd simply say, by that logic Mayer never should have fired Henrique De Castro last December. He simply needed more time. She was being short-sighted in removing him.
Of course, this is absurd. She made the right call. Mayer fired De Castro because she came to the realization that he was a bad hire from the start 15 months ago. She faced a choice: Should she double down on a bad decision or should she rip the band-aid off, face the public embarrassment of the change, pay the severance, and move on? She chose the latter.
Today, any close observer of Yahoo! can assess that this turnaround of the core business has gone badly over the past two years. Although Mayer certainly gave a shot in the arm to company morale in the first 6 months after she was hired, the sales results are getting worse - not better - and headcount is still way too high relative to the declining EBITDA.
Yahoo!'s board must make the same decision to remove Mayer now that she made in removing De Castro. Even though it will be embarrassing and costly to part ways with Mayer, this board of directors works for its shareholder. The board doesn't work for Mayer.
If Mayer was to step down, I suspect the stock price would immediately increase 10% because investors would conclude that a deal with Alibaba or SoftBank would be more likely. I believe they would be right to draw that conclusion.
But I can imagine some critics of this opinion would say that "Eric is a Yahoo! shareholder and, therefore, only cares about the stock price... he doesn't care about the long-term well-being of employees at the company." This same argument was made when Dan Loeb spoke out in favor of removing several members of Yahoo!'s board in 2011 and later Scott Thompson.
To this, I'd say: How much should we trust the opinions of tech people who don't have enough belief in Yahoo! to spend any of their money on owning Yahoo! shares and yet are quite comfortable doling out advice? Of course shareholders will always have a vested interest in seeing the stock price go up. That's the capitalist system we all choose to live in and which has served us well for nearly 250 years. In my experience, shareholders seem to know a lot more about a company, its management and board, as well as its competitive environment than casual observers tweeting about stuff they don't really follow all that closely anyway. I would much rather listen to the opinion of someone with skin in the game versus someone with no skin in the game.
Of course, there can be shareholders who advocate bad opinions. Equally, there can be dysfunctional boards -- like the Yahoo! board led by Roy Bostock who turned down the $45 billion Microsoft buyout offer in 2008 -- who have no skin in the game and yet continue to preach that shareholders are being "short-sighted" in expecting a business to turnaround even though the board keeps green-lighting bad strategic decisions.
In short, both CEOs and their boards as well as investors can advocate good and bad advice. I have made my case why I don't believe Marissa Mayer should continue as CEO of Yahoo! and why Alibaba or SoftBank should buy the company. I will leave it to other investors to consider this argument and come to their own conclusions about what's in the short- and long-term best interests of Yahoo! shareholders.
At the time of publication, the author was long YHOO, although positions may change at any time.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
TheStreet Ratings team rates YAHOO INC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:
"We rate YAHOO INC (YHOO) a BUY. This is driven by multiple strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its largely solid financial position with reasonable debt levels by most measures, reasonable valuation levels, solid stock price performance, good cash flow from operations and expanding profit margins. We feel these strengths outweigh the fact that the company has had sub par growth in net income."
Highlights from the analysis by TheStreet Ratings Team goes as follows:
- Although YHOO's debt-to-equity ratio of 0.09 is very low, it is currently higher than that of the industry average. Along with this, the company maintains a quick ratio of 2.99, which clearly demonstrates the ability to cover short-term cash needs.
- Net operating cash flow has slightly increased to $357.41 million or 8.03% when compared to the same quarter last year. Despite an increase in cash flow, YAHOO INC's average is still marginally south of the industry average growth rate of 17.73%.
- Compared to its closing price of one year ago, YHOO's share price has jumped by 29.92%, exceeding the performance of the broader market during that same time frame. Looking ahead, the stock's sharp rise over the last year has already helped drive it to a level which is relatively expensive compared to the rest of its industry. We feel, however, that other strengths this company displays justify these higher price levels.
- The gross profit margin for YAHOO INC is currently very high, coming in at 83.10%. Regardless of YHOO's high profit margin, it has managed to decrease from the same period last year. Despite the mixed results of the gross profit margin, YHOO's net profit margin of 24.87% compares favorably to the industry average.
- You can view the full analysis from the report here: YHOO Ratings Report