10/13/08 - 11:30 AM EDT
For nearly two years, I've been engaged in an activist campaign to aimed at improving the performance of Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks). No more. I sold my fund's stake last month. The risk/reward ratio of continuing to hold the stock had become too high.
When I started my activism with Yahoo!, I was attracted to the Internet company's strong brand, which continues to drive impressive traffic to its many popular properties. It's still the No. 2 search engine in the world and it's also No. 1 for email.
Any new Web company has no hope of emulating those numbers. Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks), with its online services division, has been trying to achieve credible numbers in all those areas for the last 12 years -- with little success to show for its efforts.
I believed that with better oversight from a new board and management, Yahoo! could finally capitalize on its many strengths. We've had no significant changes at either level. The company is still muddling ahead with just as many priorities, just as many staff and just as many boxes on the organizational chart. I came to the conclusion that this company is doomed to failure with the current board and leadership.
Leadership matters. It helps companies to pull away from competitors or to catch up. Unfortunately for shareholders, Yahoo! has lacked a strong CEO for seven years now. Its board has continued to approve excessive pay to executive management and themselves. They will always be remembered for turning down $31 and then $34 a share from Microsoft.
When Yahoo! Vice President Brad Garlinghouse penned the infamous Peanut Butter Manifesto in October 2006, there was reason to hope that some new ideas and energy might actually spring up from within Yahoo! to shake some of the scales from this organization's eyes.
Two years later, that letter's call for changes have gone unanswered and the prescriptions are as relevant now as they were then. I suspect the same will be said again two years from now.
Anyone holding a long position in Yahoo! is doing so for the potential value their assets might fetch in a company sale to Microsoft, not for the potential increased value current management might create from extending the current assets. It is likely that some kind of deal with Microsoft will happen. Microsoft continues to be exactly nowhere in terms of search and Web services traction.
Yahoo!'s proposed deal with Google (GOOG Quote - Cramer on GOOG - Stock Picks) appears to have stalled in regulatory approval. Most importantly, Yahoo! is trading at its early-2003 levels -- 59% below its Feb. 12 close after the Microsoft bid earlier this year.
I judged I couldn't continue to hold Yahoo!'s stock based on a strategy of hoping that Steve Ballmer will come back to the negotiating table. As he's bidding against himself, he has no incentive to come back now versus waiting and watching Yahoo!'s stock continue to drop. And, with the frozen credit markets and large media companies having seen their market capitalizations drop 30%-60% in the last month, make no mistake: Microsoft is still going to be the only bidder for Yahoo! in the foreseeable future.
A scary thought for Yahoo! longs is that, as much as Yahoo! has dropped, it could still have further to go. Yahoo! has stubbornly kept a higher price-to-earnings ratio than Google over the last two years, when it would not appear to be warranted. Today, Yahoo!'s forward P/E for 2009 is still 23, vs. 14 for Google, 15 for InterActive Corp (IAC Quote - Cramer on IAC - Stock Picks), 16 for Apple (AAPL Quote - Cramer on AAPL - Stock Picks), and 11 for Research In Motion (RIMM Quote - Cramer on RIMM - Stock Picks). If Yahoo! were to see its forward P/E contract to be in line with Google's, its share price would drop another 40% to $7.50.
Yahoo! bulls will argue that Yahoo! has $2/share in cash and that its Asian assets are worth another $3/share, so a $7.50 price target is too low. However, Yahoo! had the same amount of cash on its balance sheet in 2002, when its stock price hit its post-bubble nadir of $4.87. The current advertising market downturn likely will be longer and deeper than the one we saw in 2000-02. Those Asian assets have certainly dropped 25%-35% in the last month with the rest of the Internet sector.
Lower forward-looking guidance during next week's analysts' call could prompt more dumping of Yahoo! shares.
Nothing will change at Yahoo! until its board is revamped. Chairman Roy Bostock was unapologetic about his handling of the Microsoft negotiations when he spoke at the August shareholders' meeting. Bostock wasn't embarrassed that 33% of shareholders voted against his reelection in 2006. He should be. Over 40% voted against him in 2007 and next year he will likely break the 50% threshold. Bostock should leave now, along with other longtime directors who were hand-picked by Terry Semel and still serve.
Jerry Yang and Sue Decker also need to be replaced. They have carried on Terry Semel's Yahoo! There is little different about the company today vs. two years ago. An outsider needs to come in and clean house. There is still great talent within the company and great assets.
I wish the current Yahoo! longs well, and I suggest they find inspiration from Gordon Crawford of Capital Research Global Investors (now a 10% owner of Yahoo!). Crawford has been absolutely on the mark in his criticisms of the board (and correctly recognized that there was a major vote-counting error that understated the degree of anger aimed at the board at last August's annual meeting).
If you're a long investor in Yahoo! and think you can free-ride off the activist efforts of Crawford (or Carl Icahn), this movie will end in tears. This board will retain power and this company will drift rudderless. Passive investors who keep doing what they've been doing will keep getting what they've been getting from Yahoo!.
At the time of publication, Jackson's fund owns no Yahoo!. Jackson still holds a small long position in Yahoo! in his personal account.
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.
Monday, October 13, 2008