By Eric Jackson
08/21/08 - 12:19 PM EDT
What will Yahoo!(YHOO - Cramer's Take - Stockpickr) and its board do next to try to win back its shareholders' support?
It's highly likely they will seek to appease disgruntled shareholders by unlocking value in their collection of Asian assets, which currently make up 35% of the value in Yahoo!'s $20-a-share valuation. But Yahoo! shareholders need to be vigilant as to how this is done, especially with regard to the nonpublic entities Taobao.com and AliPay.com (the eBay (EBAY - Cramer's Take - Stockpickr) and PayPal of China, respectively).
It's been a difficult seven months for Yahoo! shareholders, who saw their shares increase in value to $30 from $19, only to drop back to pre-Microsoft (MSFT - Cramer's Take - Stockpickr) bid levels. At the shareholder meeting earlier this month, Yahoo!'s board strongly defended itself, saying it had done everything possible to achieve a deal with Microsoft. It also laid out the case for why its go-it-alone strategy would succeed and why Yahoo! still has an enviable array of assets that neither Microsoft nor anyone else can replicate anytime soon.
Yahoo! does have great assets -- that's why I first invested in the company two years ago. However, the company's board is weak, and it has exerted poor oversight while approving lavish pay to its executives and board members. Even with Carl Icahn and his colleagues Frank Biondi and Gary Chapple joining the board, this is still largely the board that former CEO Terry Semel assembled five years ago. A board that continues to be weak has the potential to continue to make poor decisions on behalf of its shareholders. That might happen sooner rather than later.
I attended Yahoo!'s most recent shareholder meeting and asked about several governance-related incidents over the last year that I felt weren't in shareholders' best interest. For example, Yahoo! decided last August to sell its $400 million-a-year Overture Japan business to Yahoo! Japan (which was essentially a sale to Softbank, the other owner of Yahoo! Japan) for $13 million. That's a far cry from the three to five times multiple of annual revenue Yahoo! typically has paid for venture capital-backed companies such as Zimbra, Rivals and Right Media.
Such a deal seems to have greatly benefited Softbank at the expense of Yahoo!'s shareholders. (And Yahoo! hasn't offered me a detailed explanation, if there is one.) Right or wrong, this appeared to be a sweetheart deal. If this is how Yahoo! operates, it's not unreasonable to believe the company could do the same thing with its Chinese partner Alibaba.com.
Chief Financial Officer Blake Jorgensen said during the shareholder meeting that Yahoo!'s collection of Asian assets (from its stake in Yahoo! Japan, Alibaba in China, and GmarketGMKT in Korea) are worth about $7 a share to Yahoo! shareholders at today's market prices. However, as Jorgensen noted, Yahoo! maintains significant ownership (through its Alibaba stake) in two significant private Chinese companies: Taobao.com and AliPay.com.
Both Chinese companies have great potential. They already are the clear leaders in their verticals in China. (eBay just retreated from the Chinese market because of its inability to compete.) Taobao.com and AliPay.com also have chosen deliberately to grab market share in the past few years by not charging users' fees. As you can imagine, such pricing has helped their user base explode. The costs for both companies are very low and they both know they can turn the meter on at any time with a very large payback.
And so here's the governance issue: How should these assets be valued if Yahoo! wants to extract value from its stake in these private companies? If you valued them today, there is no revenue and the earnings are negative. But in two years, when each company turns its meters on and begins to generate hundreds of millions of dollars, the companies will be much more valuable.
There are two ways Yahoo! could extract value from Taobao.com and AliPay.com: Agree to a management buyout with each company's management -- most likely the management of Alibaba -- or spin off these assets to Yahoo! shareholders with the stakes in the other Asian assets.
A management buyout would be another partner-friendly sweetheart deal that would greatly enrich Alibaba insiders at the expense of Yahoo! shareholders. Therefore, a spinoff is the right thing for Yahoo! shareholders. In a spinoff, even if the shares are valued low today relative to what they will be in a few years after the private entities start charging fees, Yahoo! shareholders can decide whether to hang on to their stakes.
The management buyout approach gives Alibaba full ownership of a growing asset at a significant discount to its true inherent value. Alibaba or the management teams would gain full control of these private assets at today's artificially low prices, knowing full well they are buying an asset that will be worth three to six times as much in a very short time. There's no market risk to them achieving a higher market valuation. All they have to do is flip the switch and start charging their loyal users a small fee. I would take on that kind of risk any day.
In the case of the Yahoo!-Overture Japan deal, shareholders found out about it after the fact. It was barely mentioned in an analyst call and buried in the back of a Securities and Exchange Commission filing. Yahoo! shareholders didn't have the good fortune of a large shareholder like Capital Research calling on the company to explain itself as they did earlier this month when Capital Research brought to light the significant underreporting of shareholder discontent with the current Yahoo! board. Therefore, all Yahoo! shareholders need to pay close attention now to how Yahoo! unlocks value with its Asian assets.
Softbank got a great deal for Overture Japan. Alibaba shouldn't get a great deal for Taobao.com and AliPay.com. Yahoo! shareholders deserve to be treated fairly.
At the time of publication, Jackson was long YHOO.
Eric Jackson is founder and president of Ironfire Capital, LLC, and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.
Thursday, August 21, 2008
By Eric Jackson