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It has been a year since I hung ’em up as a sell-side equity research analyst covering the Internet, and much has changed. Alibaba shares have returned to the $68 IPO price, due more to macro/China/EM issues than to Alibaba-specific ones. Google and Amazon shares have risen due to enhanced transparency and improved investor communications. Netflix is ruling the subscription over-the-top world, reshaping media as we know it. And Facebook has grown into a legitimate and powerful center of gravity in Internet/mobile/video, with Instagram and WhatsApp adding spice and youth to Facebook’s utilitarian but not hip-and-cool image.
YHOO shares and Yahoo‘s competitive position, however, are still the same. Holding aside the roller-coaster ride tied to the valuation of Yahoo’s stake in BABA, the Yahoo core business constitutes little value in its sum of parts.
The real surprise, and one backed up by recent conversation, is that Yahoo’s core business remains an elusive yet dreamy prospect for private equity. Today. If only Yahoo management would act like private equity now, and treat Yahoo like a mature media company worthy of a real turnaround … then Yahoo’s current shareholders (of which I am one) would benefit from the strategic and financial value that is buried underneath all that purple-hued peanut butter in Sunnyvale. In my view, a streamlined Yahoo core business could be worth $12 billion in three to five years, as opposed to $3 billion to $5 billion to private equity today.
Here’s a five-step plan for Yahoo’s current CEO Marissa Mayer, or, more likely, her successor, as I would doubt that she would care to lead Yahoo through this difficult transformation. (Not an anti-Mayer view, but Mayer seems like a growth-focused individual, not a an efficiency expert.):
Buy back shares massively, today, before the turnaround. One way to do this is to split off the core business – using an exchange offer, like Viacom did for Blockbuster long ago. With or without a split-off, the company has $7 billion in cash and at ~$30 per YHOO share, that could equate to a 25 percent reduction in shares outstanding, increasing EBITDA and free cash flow per share by one-third, all else equal. A split-off would enable the Yahoo board to align executive compensation with the performance of units that the Yahoo exec team controls — according to my calculations, the Yahoo core business constitutes 10 percent to 15 percent of the total sum-of-parts value, around one-third if you include the $7 billion cash balance.
Don’t rush to spin the BABA stake now. Alibaba shares look cheap to me, and Chinese equities are massively out of favor. If and when commodities/emerging markets stabilize, investors will return to secular growers like BABA, particularly into the seasonally strong fourth quarter. Collaring the asset for six to 12 months could be nearly costless, and could give investors and executives room to breathe. An important (but undiscussed) catalyst for recent weakness in BABA shares is that Yahoo, an owner of 15 percent of the shares, is acting like a forced seller of BABA shares. Forced selling often drives a wave of sympathetic (opportunistic) selling in anticipation of that transaction. If things get worse with China broadly or BABA shares specifically, the Yahoo CFO would look like a hero by protecting the downside. Take the risks you can control, and minimize the others.
Cut costs, for real, generating up to $1 billion in savings. Yahoo will generate around $1 billion in EBITDA this year on $4 billion to $5 billion (flat) in net revenues (ex-TAC), equating to less than a 25 percent EBITDA margin. EBITDA is down roughly $300 million from prior year levels, if you simply annualize the 2Q15 year-over-year decline in EBITDA. Stock comp is massive, partly due to additional deep-in-the-money shares vesting every day. Low-margin acquisitions (BrightRoll, Polypore, Flurry) are driving Yahoo margins lower as direct sold premium ad sales erode. A quick look at the financials shows more than $3 billion in costs (excluding TAC and stock comp) and 11,000 employees – roughly $270,000 per head. Neither of these figures, employee headcount or cost-per-head, makes sense today. When private equity (Bain, Providence, Silver Lake) was actively pursuing Yahoo a few years ago, pre-Marissa, there was a plan to reduce headcount to around 6,000, by eliminating redundancies, outsourcing costly functions, focusing on things Yahoo does well, and bringing salaries into line. At the average cost per employee of $270,000, that cost-cutting effort would create over $1 billion in savings. There would be some revenue lost from this effort, but not that much.
Revisit the Google paid-search deal. The competitive situation was decidedly different when the DOJ stopped the Yahoo/Google search deal in 2008. Yahoo had more than 15 percent share in search queries, and Facebook, still being run out of an overcrowded office in downtown Palo Alto, was far from a center-of-gravity in Internet advertising. The addition of Yahoo’s search query volume to Google’s existing share would no longer interfere with the competitive dynamics in Internet advertising, in my view. With Yahoo’s eroding market share in search queries, a Google deal would add an incremental $400 million in revenues, I estimate, with zero incremental costs. It is unclear that Google would do anything to increase regulator scrutiny at this time, but an arms-length deal has a chance.
Stop referring to Yahoo as a “guide” or “the world’s largest startup.” Neither of those descriptions makes any sense, really, to anyone. The Internet needed a guide in the mid-90’s when Jerry and David started Yahoo. Google, Facebook, Twitter and other platforms have obviated the need for such a thing. Social and search, predominantly app driven, drive online media consumption, not an old school, desktop-based guide. And “the world’s largest startup” – the notion of a startup connotes risk and the potential to lose investor’s capital. Yahoo is a mature digital media company with a vibrant global audience and massive financial resources.
I have plenty of other thoughts about how a more efficient Yahoo could improve its competitive position, through strategic acquisitions, business development, and investments. But first things first … Yahoo needs to get its house in order.
Disclosure: As of Monday, October 12, 2015, I hold a long equity and options position in YHOO shares, consistent with my view that the true strategic value of Yahoo has not been realized. While I do not anticipate a change in my views or my holdings, such a change may happen in the future. Neither I, Jordan Rohan, nor my advisory firm, Clearmeadow Partners LLC, has any relationship with Yahoo, its board, or its management team.
Jordan Rohan is the founder and managing partner of Clearmeadow Partners, an advisory firm focused on helping Internet companies accelerate growth and increase asset value during times of significant change. Throughout his 15-year career as a Wall Street analyst, Rohan developed a reputation as a thought leader on media, e-commerce, advertising technology, search and social media business models, providing investors with a differentiated view on relative value in the Internet ecosystem. He was personally involved with dozens of IPOs, including Facebook and Google. He won many awards as an analyst, including the WSJ’s Best on the Street in 2005 and 2007. Reach him at jrohan@clearmeadow.com or @JordanRohan.
This article originally appeared on Recode.net.
