Yahoo! Back in the News Because of Activist Investor : What Wall Street's Saying

NEW YORK (TheStreet) - Yahoo! (YHOO) found itself back in the news on Friday after activist investor Starboard Value Partners announced it had taken a "significant ownership stake" in the search firm and announced ways for it to boost shareholder value.

Starboard Value Partners send Yahoo! a letter asking the Internet giant to take action to boost shareholder value. Among the changes the activist investor wants to see from Yahoo! included a potential merger with AOL. Starboard also suggested the company unlock value and tax efficiencies from its Alibaba (BABA) stake and Yahoo! Japan; reduce expenses, specifically within the display business; and halt its "aggressive acquisition strategy."

Yahoo! CEO Marissa Mayer said in a press release on Friday that "As part of our regular evaluation of Yahoo's strategic initiatives to drive sustainable shareholder value, we will review Starboard's letter carefully and look forward to discussing it with them."

Watch the video below for more on Starboard's proposal for Yahoo to merge with AOL:

Must Read: Yahoo! Shares Jump Amid Reports of Potential Deal With AOL

Further in the letter, Yahoo! and Mayer noted the company will "continue to focus on evaluating various capital allocation initiatives, an update to which we plan to provide on our third quarter earnings call."

Yahoo! is scheduled to reported third quarter earnings in October. Analysts surveyed by Thomson Reuters expect the Sunnyvale, Calif.-based company to earn 30 cents a share on $1.046 billion in revenue.

Yahoo! shares rose 4.4% on Friday. The stock was trading roughly flat at $40.69 at last check on Monday. Here's what analysts had to say:

Youssef Squali, Cantor Fitzgerald (Buy; $43 PT)

We're not surprised by Starboard's overture (or Yahoo!'s response) last Friday to YHOO's management to 1) minimize the tax bill from the sale of its non-core Asian assets and maximize the return of proceeds to shareholders, 2) act fast on core to re-ignite top line growth, or 3) move aggressively to protect margins and maximize FCF. To be clear, none of what Starboard is requesting is new, in our view. Their claim that Yahoo! could reap substantial value from a tax-efficient treatment of the sale of its minority interest in Alibaba Group and Yahoo! Japan is consistent with what we've been saying - that there is up to $15/share of potential upside on top of our $43 PT (which assumes full tax treatment). As always, the devil is in the details, and it remains to be seen how Starboard is recommending that Yahoo! legally structures the transactions to minimize taxes. The proposed AOL combination has also been widely discussed in the media, and while we see merit in how the two companies could reduce expenses given their redundant operations, we believe that it'll be much harder to improve the combined top line given that both companies are losing share in Search and Display.

Must Read: Yahoo! Is in Play Thanks to Activist Starboard Buying Big Stake


Brian Wieser, Pivotal Research Group (Hold; $41 PT)

Starboard announced it acquired a "significant" ownership stake in Yahoo and published a letter proposing ways to unlock value. We agree with Starboard's premise that significant value could be created if Yahoo followed the letter's proposals, although for the bulk of value to be created Yahoo must be able to monetize its stakes in Alibaba and Yahoo Japan tax-efficiently. The other proposals - cost cuts, an elimination of M&A and a sale to AOL - would also create value, although we suspect a proxy fight may be necessary for them to play out, if Yahoo does not develop an alternative plan of their own. ... We agree with the central premise that these initiatives would produce significant value for shareholders and that Yahoo shareholders and the company itself would benefit if the company followed through with as much of the plan as possible.

Rick Summer, Morningstar (Hold; $42 fair value)

Some of the elements of Starboard's plan make strategic and financial sense, particularly an effort to reduce expenses and avoid aggressive acquisition strategies (absent the firm's recommended merger with AOL). Currently, we are placing a discount on the value of Yahoo's 15% ownership in Alibaba Group because we have looming questions about the firm's future returns on capital. A strategy to return this capital to shareholders and avoid the reinvestment risk would represent upside in our model, which we estimate at $47 currently.

Starboard also suggested two additional elements to its activist strategy: greater tax efficiency for the eventual liquidation of the remaining holdings in Alibaba Group and Yahoo Japan and the exploration of a merger with AOL. We are not optimistic about the firm suddenly finding a more tax-efficient strategy, as this challenge is been explored by several management teams and advisors over the past several years. We think the likelihood is low that Starboard will provide a magic solution for Yahoo, but the stakes are high. The tax liability related to the remaining holdings of Alibaba Group is approximately $11 per share. With respect to a potential merger with AOL, we believe the strategy is risky and does nothing to improve Yahoo's narrow moat or negative moat trend. Advertisers are demanding greater targeting capabilities, and these companies offer little in the way of real-time targeted advertising that is as effective as Google GOOGL and Facebook FB, in our opinion. Also, a combination would offer modest cost savings at best, in our view. It is clear that the outlook and opportunity for Yahoo's core business have been waning, but the solution isn't obvious.

Must Read: Yahoo!'s Slide from Alibaba IPO Continues: What Wall Street's Saying

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 a few notable 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, good cash flow from operations, expanding profit margins and solid stock price performance. 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 cash flow growth rate is still lower than the industry average growth rate of 41.40%.
  • 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.
  • YAHOO INC's earnings per share declined by 13.3% in the most recent quarter compared to the same quarter a year ago. The company has suffered a declining pattern of earnings per share over the past year. However, we anticipate this trend reversing over the coming year. During the past fiscal year, YAHOO INC reported lower earnings of $1.26 versus $3.28 in the prior year. This year, the market expects an improvement in earnings ($1.38 versus $1.26).

Must Read: Yahoo! Should Split Into Yahoo!, Yahoo! Japan and Yahoo! Alibaba

--Written by Laurie Kulikowski in New York.

Follow @LKulikowski

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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