Investment analyst Adam Morton at Kennedy Management Company provided what I thought was a more rigorous approach to my method (seen here) of calculating Yahoo!'s enterprise value and EV/EBITDA multiple.
In his calculation he correctly isolates the values of Alibaba Group's privately held assets Alipay & Taobao, providing a value range of $0.44 to $0.89 per Yahoo! share for Alipay and $0.71 to $1.42 per Yahoo! share for Taobao.
Adam also includes 10 cents per Yahoo! share for the small amount of debt Yahoo!'s balance sheet.
Accounting for the asset values of publicly traded Alibaba.com and Yahoo! Japan, he arrives at an enterprise value range of $5.510bn - $7.070bn for Yahoo!, based on the July 26 close price for Yahoo!'s shares.
That equates to 3.3x - 4.3x 2010 EV/EBITDA multiple. Compare that multiple range to traditional media stocks from DISH Network to CC Media Holdings, which trade in a range of 4.8x to 14.2x. See the exhibit below for EV/EBITDA multiples for several traditional media companies.
My own calculations have Google trading at 10.1x, eBay at 6.9x, and Amazon at 18.9x 2010 EV/EBITDA, respectively, based on closing prices on 7/31/2010. See our Internet valuation sheet here.
Yahoo! is by far the most inexpensive stock of all major Media and Internet companies. Adam includes a chart below that shows Yahoo! valued at $19 to $21 at EV/EBITDA multiples of 7.7x to 9.2x.
Source: Adam Morton, Kennedy Management Company
Question is should we buy the stock? Despite the results from the 2Q10 report, we have slowly began to warm up to future of the Yahoo! story.
About one year ago we wrote this about Yahoo! (seen here):
"I would stay on the sidelines with Yahoo! (YHOO) for now because of its dependence of branded advertising as a core function now that it has decided to essentially exit the search business. Unlike search advertising, branded advertising is facing secular pressures such as unlimited inventory which is depressing CPM pricing, an advertiser mix shift from higher price guaranteed inventory to lower priced non-guaranteed inventory, and CPM pricing pressure due to inventory being purchased through lower priced sales channels. I do not foresee those challenges abating anytime soon, even in an economic recovery. Branded advertising declined 12% for Yahoo! in the first half of 2009, in-line with the broadcast networks and slightly better than outdoor advertising. Domestic search was down 5% y/y in the first half 2009 but down 13% in 2Q09, so clearly no offset there. The shares are trading at 5x 2010 EBITDA and could be an attractive stock for value investors given that it is no longer a value trap. The Microsoft search deal should lift margins and free cash flow substantially but that’s an event that is 24 months out. A Taobao IPO could be a positive catalyst for the shares but the timing is uncertain. And I am not buying the analogy to DELL – Yahoo has lost a competitive advantage by giving up search. Street sentiment has improved with several upgrades to buy in the past two months but I am not convinced yet. Yahoo is a turnaround story but there are too many “ifs” and uncertain catalysts layered on top of secular challenges in its now core display business for me to buy this stock."
That thinking turned out to be spot on. However, I think Yahoo!'s management could be looking at alternatives to create shareholder value. Particularly, I believe they are studying the actions of John Malone at Liberty Media and how he has successfully enhanced the value of his tracking stocks through asset spins, swaps, and aggressive share repurchases.
We think now is the time for Yahoo! to financial engineer they way out of this mess. First, we believe that they should lever the balance sheet and use the cash to aggressively shrink equity. According to our calculations, the P&L can comfortably sustain interest expense from about $3 billion of debt or leverage of under 2x. That on top of the already existing $3 billion share repurchase program could lead to a 30% increase in the share price.
Management at the last analyst day dialed back expectations about a divestiture of the Yahoo! Japan asset walking investors through the math showing that doing so would be anti-dilutive. Ok on that. However, they could very well consider a transaction with the Chinese assets. A tax free spin of those assets would provide investors with additional currency.
Lastly, I will go out on a limb here, but I think it is time that management faces reality. Yahoo!, like AOL, has great asset value but the business they are in has changed fundamentally. After acting on the above advice, free we might add, and when Yahoo! is on better footing, management should seriously consider selling Yahoo!. Probably to Microsoft or to a traditional media company. Newscorp or Disney would make the ideal fit for Yahoo!. They could learn from the mistakes of Time Warner and AOL and make it work. Maybe private equity can take a hard look here.