Alibaba IPO to Hurt Yahoo

Morningstar analysts are concerned about potential liquidity issues of Alibaba Group for Yahoo shareholders and the lack of opportunities for the firm to invest

Rick Summer, CFA, CPA 19 September, 2014 | 11:31AM
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We have erred on the side of caution in the past with respect to Yahoo's ability to realize value from its holding in Alibaba Group, which is set to price on the evening of September 18. We believe Yahoo (YHOO) has primarily been a vehicle for investors to participate in the potential upside in Alibaba Group, but we have historically provided a margin of safety to account for valuation risk, the uncertainty of the timing of an IPO, and the potential for return of capital to Yahoo shareholders.

Based on the pending IPO and our published fair value estimate for Alibaba Group of $90 per share, we are revising our fair value estimate for Yahoo to $42 from $39. We still do not see a compelling reason to recommend the shares of the narrow-moat firm, particularly based on our belief that Yahoo is disadvantaged versus the richer advertising platforms of Facebook (FB) and Twitter (TWTR). 

Our largest concern with respect to the potential liquidity of Alibaba Group for Yahoo shareholders is the lack of opportunities for the firm to invest in high return projects. Presently, Yahoo is set to sell nearly 122 million shares in the offering, and retain a 16.3% ownership interest in Alibaba Group.

While we are giving the firm full credit for the Alibaba shares that are to be sold at the expected IPO price of $68 per share, we are taking a 20% haircut from our fair value estimate of $90 to account for our concern that the shares are not reinvested wisely. If we did not take a haircut, our fair value estimate would be $47. Still, we prefer to be cautious, since the turnaround in Yahoo's core business has been slow to materialise.

Yahoo may be able to turn around its core business, but the divide between possible and probable is wide. Marissa Mayer has been at the helm for more than a year, but declaring a successful turnaround is premature, in our view. We believe the company can improve its near-term fortunes, but Yahoo's longer-term positioning and durability of its advantages are unclear.

Yahoo’s large base of more than 800 million users is an important asset, but management must appropriately navigate several hurdles in order to effectively turn around its core business. First, although Yahoo's focus on display has been its strength, users and advertisers are spending more time and money on other websites like Facebook, a social networking giant. Second, while Yahoo’s media properties including its homepage, Yahoo Sports, and Yahoo Finance are well suited to a desktop world, the company has done very little to connect mobile applications to its more traditional web experience.

Yahoo has continued to lose market share in online advertising to other destination sites such as Facebook and Twitter. Currently, Facebook is the most heavily trafficked website in the world. Furthermore, Facebook has been able to gather superior information about its users, which helps advertisers target their campaigns. Although this industry is still relatively nascent, we believe these efforts will shift offline dollars to social networking companies more rapidly than to more traditional firms dependent on display like Yahoo and AOL.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Facebook Inc A318.15 USD-4.14Rating
Twitter Inc37.30 USD-2.97Rating

About Author

Rick Summer, CFA, CPA  Rick Summer, CFA, CPA, is a senior stock analyst with Morningstar.