Will Alibaba Buy Yahoo?

Buyout talks, not earnings, could be the key indicator for YHOO and BABA stocks.

Over the last few weeks, one of the biggest market stories has been the successful IPO at Alibaba BABA, which raised a massive $21.8 billion in its public market introduction.  This is the largest tech IPO we have ever seen and this suggests a strong wave of bullish optimism with respect to the lower end retailers in emerging markets.  So far, this has failed to translate into assets like the iShares MSCI Emerging Markets Asia ETF EEM, which is still trading near 3-month lows.  But going forward this might not be the case for specific stock names (like BABA) which are still well-positioned for relatively stable growth. 

One factor that supports this argument is the prospect for potential buyout proposals directly focused on Yahoo! YHOO.  When we look at the tech giant’s long-term revenue performances, earnings growth has been relatively flat over the last decade as Yahoo continues to lose traction in the digital advertising space relative to counterparts like Google GOOG.  These trends have generated some critical questions for those invested in the company, and the latest news from Alibaba increases the likelihood that the relationship between these two companies could strengthen -- either as an increased partnership or in an outright buyout of Yahoo itself.

Watching the Trends

It should be remembered that there is already a strong connection between Yahoo and Alibaba.  Yahoo’s 22.6% stake in Alibaba led to revenue gains of nearly $8.3 billion in the latest IPO, and the two companies have been closely connected in terms of its strategies to promote and support smaller businesses in emerging markets.  This puts Alibaba in a credible position to buy Yahoo, given all of the excess capital the company now controls after its IPO.  This does not necessary make a Yahoo buyout a ‘lock’ by any means.  But it does suggest that this is a possibility that should continue to be at the forefront in investors’ minds as we head into next year. 

(Chart Source:  CornerTrader)

“The next question investors should be asking is whether or not a buyout move would be beneficial for Yahoo” said Vlad Karpel, options strategist at TradeSpoon.   “The stock has seen some significant gains over the last few months, rallying from the lower $30s to hit highs above $43 as CEO Melissa Mayer continues to implement buyout strategies of her own.”  But Yahoo stock is only now trading back toward its 2006 highs and many analysts have made the argument that Yahoo’s lackluster performances in areas like display-ad revenues mean that the company is still in need of a major overhaul at the upper levels.  Last quarter, this metric showed a drop of roughly 7% in Yahoo’s earnings report.  So it’s not entirely surprising to see another groundswell of support for further changes at the leadership levels. 

Does this mean that Yahoo is one of the market’s weak gazelles just waiting to be eaten by the young Alibaba lion?  Not if we believe the argument that Alibaba is simply not in the position to guide managerial decisions in a company that is as diverse as Yahoo.  But it does mean that this will continue to be an important factor that could affect positioning for those invested in YHOO.