Alibaba A Bright Spot For Yahoo Amid Recent Headline Woes

Rob Sanderson of MKM Partners maintains his Buy rating and raised his price target on Yahoo! Inc. YHOO shares by $7 to $51, citing revaluation of Alibaba Group Holding Ltd BABA shares.

Yahoo is set to report its third-quarter earnings results on October 18 after the market close. Results will likely be a nonevent for the stock with the acquisition by Verizon Communications Inc. VZ pending and no conference call on the schedule.

But, amid the recent negative headlines surrounding Yahoo, Alibaba is the bright spot for the company.  

After the core business sale, the value of the stub is driven primarily by tax considerations on the Alibaba stake (67 percent of untaxed SoTP valuation) with smaller consideration for potential tax liability on Yahoo! Japan (14 percent).

Related Link: 5 Potential M&A Deals In The Media And Internet Space

“The potential $1 billion discount that VZ is reportedly seeking would only equate to about $1 per share, or 2 percent of pre-tax valuation. The potential value of IP is in a similar range and potential upside to our SoTP analysis if/when sold. We do not expect to learn much on tax treatment and therefore see a benign reaction in the shares post-earnings,” Sanderson wrote in a note.

During recent meetings with Alibaba senior management, the company said they do not see a tax efficient buy-in of its shares owned by Yahoo. They said if there was a tax-free mechanism, it would have already been done.

Any Other Options?

Although Alibaba is the natural buyer, Sanderson is not ruling other strategic parties as a 15 percent stake in Asia’s largest commerce platform, public cloud and broad portfolio of assets would attract firms such as Amazon.com, Inc. AMZN, Wal-Mart Stores, Inc. WMT, Alphabet Inc GOOGL GOOG, etc. Alibaba may want to prevent this situation.

“The spread between a tax-free and fully taxed distribution of BABA shares is $16 per share to YHOO. We have raised our discount rate from 15 percent to 20 percent as the most logical buyer appears to have low interest at this time,” Sanderson highlighted.

Verizon's Security Breach, Lasting Impacts?

Verizon’s lawyers are determining if a security breach had a material impact on the business, while Sanderson said a MAC clause trigger is unlikely.

“Given the stickiness of Email, and the fact that the breach occurred two years ago, we believe the potential harm to users and advertisers has diminished (unless hackers indeed still have access to YHOO's network),” Sanderson elaborated.

Sum-Of-The-Parts Valuation, Justification

“Our new SoTP valuation assumes the full $4.8 billion purchase price for core Yahoo! or $5 per share, with $33 per share from BABA at the current stock price (with a 20 percent discount for taxes and liquidity), $6 from Yahoo! Japan (fully taxed) and $7 of net cash,” Sanderson added.

The analyst, who has a price objective of $130 per share on Alibaba, said assuming a fully taxed Alibaba and a fully taxed YV (at 40 percent on gains above the cost basis), this would imply a 20 percent return in Yahoo shares.

Sanderson continued that the returns would be same in the event of a tax shelter of 500bps (i.e., from 40 percent to 35 percent).

“After that, every 100bps of incremental tax shelter would drive 120bps of outperformance in the YHOO stub, all else equal,” Sanderson added.

At time of writing, shares of Yahoo were up 0.94 percent to $41.83.

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