Yahoo!'s shares are down 4% in the past month versus a 10%, 8%, and 7%, improvement for Google, Microsoft and the S&P 500, respectively. The shares are cheap, trading at a low 5x 2010 EBITDA versus 13x for Google and lower than traditional media and entertainment companies that are trading in the high single digits. My DCF on the stock points to a $22 value for the shares over the next 12 months, a full 38% appreciation from where the shares are trading today. Wall Street analysts are bullish, with only 2 sell ratings, and with several major investment banks recently changing their recommendations to buy, with price targets in the low $20s.
In my write-up, Stocks to Buy in the Cyclical Advertising Recovery, I suggested that I would stay on the sidelines on the shares in the near-term due to Yahoo!’s reliance on branded advertising, which as a business is clearly improving, but in my opinion, continues to face a bevy of challenges. Add to that AOL, which is becoming a formidable competitor hell-bent on showing investors that it is a credible standalone company, Yahoo! is facing a mountain of secular issues.
However, I also suggested that the stock could be attractive to value investors willing to wait ~24 months for the full benefits of the Microsoft deal to show up in margins and free cash flow, in addition to a Taobao IPO, which could unlock additional value.
In 2010, on its own, without the Microsoft deal, revenues should grow 3-4% and EBITDA about 7% as margins improve due to the heavy cost cuts. And with very little pressure on working capital, we should see a substantial free cash flow boost north of 20%.
The company should exit 2010 with over $5.5 billion in cash, which it could use to shrink equity. Unlocking value in the Asian assets via sales provides additional runway for the shares. Even within its wholly owned portfolio, Yahoo can shed assets such as Hotjobs and Yahoo! Personals and use the cash for share buybacks or further investments in the core business.
Furthermore, it is time to lever the balance sheet. According to my calculations, the P&L can comfortably sustain interest expense from about $3 billion of debt or leverage of under 2x, to which management can use to shrink the equity cap by 15%. Liberty Interactive (LINTA) recently raised $1 billion of debt due 2019 with a 7.5% coupon and the company was already levered at 3.5x prior to the debt raise. The caveat here is that Carol Bartz is no John Malone.
Yahoo!’s management and the board have a fiduciary responsibility to take action on items that could improve shareholder returns. None core asset sales and a massive share repurchase is what’s needed to get the shares moving in the right direction. Operationally, with the cost cuts, investments in the core, and the Microsoft search deal, management has done the right thing. Now it is time to do more.
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