The Wall Street Journal-20080119-breakingviews-com - Financial Insight- Yahoo-s Ripe for Shake-Up- Activists Could Unlock Value By Outsourcing Searches- Spinning Off Asian Stakes
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breakingviews.com / Financial Insight: Yahoo's Ripe for Shake-Up; Activists Could Unlock Value By Outsourcing Searches, Spinning Off Asian Stakes
Yahoo chief Jerry Yang recently summarized a plan to turn the company around by becoming the start page for every Internet user across the globe. What Mr. Yang failed to provide, however, was a convincing solution to Yahoo's existential crisis. The Hamlet of the Web won't succeed by simply trying to become a start page. Yahoo is navigating the waters of Internet advertising like a goldfish evading a shark, in the form of Google. Activist investors ought to take heed -- Yahoo is ready for a shake-up.
Yahoo, based in Sunnyvale, Calif., has many ingredients that make it a tantalizing target for uppity investors. There's a discredited management team, a corporate strategy in need of a makeover, stock- price underperformance, a large free float with no controlling shareholder, cash on the balance sheet and many moving parts whose values don't appear to be adequately reflected in the Yahoo share price -- particularly its investments in two hot Asian Internet firms.
Consider the management question. A month after Mr. Yang, a Yahoo founder, took over from former Hollywood studio boss Terry Semel in June, he promised action to turn around the flailing Internet titan within 100 days. Nearly 200 days later, there is little sign of this. Since he took over, Yahoo stock has dropped 23%, while Google's has added roughly 10%. In the past two years, the company's value has been halved, so it is hard to see how investors would oppose a management shake-up.
On strategy, Yahoo has many strengths, but its primary weakness remains in search, where its U.S. market share has dropped to 17% from 22% a year ago, despite investing mightily to catch up to Google. An activist would almost certainly pressure Yahoo to swallow its pride and hand its search traffic over to Microsoft, or even Google, for a fat fee. Outsourcing search could boost Yahoo's revenue from the business by at least 30% to $3.5 billion, according to some analyst estimates.
Then there are Yahoo's stakes in Yahoo Japan and Alibaba. Although they fluctuate in value, they currently are valued at $8.4 billion and $4 billion, respectively. If monetized, the two stakes, which represent a huge chunk of Yahoo's $28 billion of market value, could provide a windfall for the company's shareholders. But there is a problem: Yahoo would incur steep capital-gains taxes in a sale.
That is, unless Yahoo gets creative with its finances. And this may be where an activist with a little corporate finance up his sleeve could make a big difference. According to Sanford Bernstein analyst Jeffrey Lindsay, the company could, for example, employ what is known as a reverse Morris Trust structure. This would essentially allow Yahoo to put the stakes into a new listed entity, let's call it Yahoo Asian Investment Co. (Yaico), which could then be spun off to Yahoo's shareholders tax-free.
The key to preserving the tax benefits of such a deal would be the presence of another player willing to merge with Yaico without taking a majority. For example, Chinese search engine Baidu.com, valued at $8.7 billion, might snap at the chance as a strategic venture. Yahoo shareholders would then be in a position to capture greater value for the Asian investments. Yahoo's $1.5 billion in cash, added to the Yahoo Japan and Alibaba stakes, represents about $10 a share of value, roughly half the current share price.
After outsourcing search to Google and reaping the cost benefits of a lessened head count -- another step investors would like to see -- Yahoo's stock could be worth as much as $36, according to a breakingviews.com sum-of-the-parts analysis, or as much as two-thirds more than the current share price. For the right marauding investor, Yahoo looks like glistening treasure. Like all worthy plunder, it won't come without some effort. But for an activist hunting for a target, it looks like a pretty appealing start page.
-- Jeff Segal and Rob Cox
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This column is by breakingviews.com, an online financial commentary site.
