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Yahoo: Still A Buy, Despite All The Drama

The very public drama surrounding Yahoo! has all but guaranteed that a deal for the company will happen, and virtually no investors even care about the companies actual operational condition. But, should a deal not happen in the way Wall Street may want, we think Yahoo!'s assets and valuation will put a floor under the stock.


However, going forward, we think Yahoo! shares will outperform, for the reasons below.

First and foremost, we think the shares will outperform due to a takeover of the company. Currently, there are several plans circulating around Wall Street. They are:

1 - Selling 20% to SIlver Lake, Microsoft (MSFT), and Andreessen Horowitz: This consortium, according to various media reports, has offered $16.60/share to buy 20% of Yahoo!. This equtes to upside of around 6.27% from current levels. This scenario presents Yahoo! with both opportunities and challenges. On the one hand, the company will gain the expertise of Anreeessen Horowitz, which has vast experience running tech companies, and could be the cure to Yahoo!'s ailing core businesses. However, Yahoo! would be giving up a significant amount of its control at a relatively low premium. This consortium is reported to demand a heavy say in the selection process for Yahoo!'s next CEO, and will most likely seek board seats.

2 - TPG Capital/Greylock: A sale of 20% to this consortium would bring in less prestigious investors than a sale to Silver Lake, Microsoft, and Andreessen Horowitz, but TPG & Greylock are said to have offered about a dollar more per share. Buying 20% of Yahoo! at $17.60, or a 12.7% premium, is a lot more tempting.

3 - Selling the entire company: The PIPE deals presented above will most likely not sit well with Yahoo! shareholders. And while they value the company at a premium to its current market value, it is not enough. Selling the whole company is a far better idea. Blackstone & Bain Capital are rumored to be preparing a bid for all of Yahoo!, valuing it at $25 billion, or $20.16 per share. That is a 29% premium, and is far superior to a private equity investment. These buyout firms are likely to partner with Alibaba ad Softbank, who have made no secret of their desire to buy back Yahoo!'s stakes in them. This deal presents 2 complications however. The first is financial. A follow up Reuters report highlighted the difficulty of securing debt financing for this leverage buyout. The loan market has shrunk, and investors are unwilling to support high multiples of leverage. That being said, Yahoo! still generates plenty of cash. Estimates call for EBITDA of $1.5 billion in 2012 and 2013. Potentially more complex is the political climate. Any deal involving Alibaba will be viewed with skepticism in Washington, for letting a Chinese company have access to the largest email provider in the United States may not be seen positively by regulators. However, we think a deal will be structured in a way that Alibaba gets control of its stake, not the core Yahoo! business. Further complicating matters is the Alibaba ownership structure, where selling Yahoo! could trigger a change in control, thus giving Alibaba and Softbank the right to buyback their stakes. Therefore, we view it as essential that they be involved in the deal from the outset, to maximize the value of Yahoo!'s Asian assets.


Yahoo! is no doubt a company in transition. But interim CEO Tim Morse is already doing a far better job than any of Yahoo!'s 3 prior CEOs. He is facing a monumental challenge trying to turn around Yahoo!, and is faced with a difficult board. Yet, we think Yahoo! is a compelling investment at these levels. Some sort of deal for Yahoo! will happen, and even if it does not, Yahoo! is undervalued based on its assets alone. Analysts agree. Credit Suisse sees the stock at $19 and S&P rates it a strong buy with a target of $20. The Reuters average price target is currently $18.16, representing upside of 16.26% from current levels. Yahoo! is a company that is facing deep challenges, but they are challenges we think it will overcome. And we think that investors who have the patience and conviction to stick with the company will be rewarded.
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