Imma Be a BABA Bull: YHOO, The Morning After

After publishing a recent post in the Harvard Business Review and Re/code about how the Alibaba deal came together, I have received many inquiries about what Yahoo is worth, and how it will trade “the morning after” the big shindig of the pricing of Alibaba’s IPO on Thursday evening. I am a Yahoo shareholder, having long held onto my shares since I left the company in 2009, awaiting the events of this week. So I have a vested interest in this question, as well.

I went to look for valuations from the experts, and saw that most of the Wall Street analysts who usually publish on Yahoo have been silenced by their firm’s role in the BABA IPO. At the same time, there have been some really interesting articles and blog posts recently taking about whether YHOO’s path would be similar to the experience of so-called “proxy stocks,” such as GSV Capital (GSVC), which had large stakes in Facebook and Twitter before their IPOs, and traded down following those events. Another similar example provided by Michael Santoli is how 3Com traded in advance of and right after the Palm IPO.

While really interesting, those proxy analyses don’t focus on the fundamental value of the sum of the parts. So I decided to dust off my analyst hat and see what the market is saying about the values and possible levers for upside/downside. The table below is what I came up with; the column at the far right and the conclusions at the bottom are what I found most interesting.

But first, I made a few assumptions. I used a multiple of six on core-business EBITDA, because I don’t see much growth there, for reasons well documented by others. For those who disagree, each multiple point is worth about $1.50 per Yahoo share.

I assumed full tax rates on Yahoo Japan and Alibaba in the event the positions are sold, though many have written about possible tax arbitrage situations if Yahoo were purchased by Alibaba or SoftBank, or if tax rates in Hong Kong prevail. If you believe that, there is upside to these figures.

I applied a 20 percent liquidity discount to YHOO’s Yahoo Japan stake, and none to the Alibaba stake. My thinking was that BABA will be relatively straightforward for YHOO to sell after the deal, but Yahoo Japan will not. Yahoo will hold 16-17 percent of BABA post-IPO, and if it plans to liquidate that over time, it is unlikely to meaningfully move the stock, considering the liquidity for future dispositions with BABA’s pending NYSE listing.

For Yahoo Japan, however, SoftBank and Yahoo together own about 77 percent of the shares, and only the remaining 23 percent or so is publicly traded on the Tokyo Stock Exchange. It would not be an easy matter for Yahoo to unload its 36 percent stake into a public market in which such a small piece of the company trades, among other issues.

Given those assumptions and using the high of the revised filing range as the IPO price, it looks like the market is assuming Alibaba will trade at a value of around $190 billion, or a little over $80 per share. This would imply 20% in appreciation right out of the gate from the stated high-end of the pricing range of $66-68 per share.

What I thought was particularly interesting was that the specific IPO pricing level is almost irrelevant to the value of Yahoo’s shares; for every $1 per share change in the IPO price, it only amounts to less than a dime of value to YHOO shares. So if the IPO is priced above the range at $70 per share, it only makes a $0.18 per share of difference to YHOO’s share value versus my assumptions.

On the other hand, the real story is how BABA trades after the IPO, given YHOO’s continuing stake and the higher implied trading values, and the much broader range of possibilities than tinkering with the IPO price by a few dollars per share. For every $1 per BABA share, YHOO’s retained BABA value will represent $0.24 per YHOO share. This is after considering a full tax rate of 35 percent; the ratio is even higher if you believe there is a tax angle here. So if BABA trades up to $225 billion valuation ($96 per share), for example, it adds about $3.60 to YHOO versus the math in the table ($.24 times $15 per share, the difference between $81 and $106). The reverse, of course, is also true.

The other interesting observation to me was that Yahoo’s residual stake in BABA, after selling a portion in the IPO, appears to work out to about 47 percent of YHOO’s total value (where YHOO is trading today), while pro-forma cash (boosted from the sale of part of its BABA position in the IPO) and its stake in Yahoo Japan are worth about 33 percent, leaving the Yahoo core business value at roughly 20 percent.

Those pieces — Yahoo core, cash pro-forma the IPO, and Yahoo Japan — work out to a combined value of around $23 per share (see table). Therefore, a quick way to do the math of where YHOO should trade on Friday is to take BABA’s price x $.24 plus $23. For example, at $100 per BABA share, YHOO should trade around $47; if BABA settles at $70 per share, YHOO should trade around $40. If YHOO turns out to be less than those values, then it may be cheaper to buy BABA through YHOO; if it is more, then the market may be assuming a better tax case than I am.

I am an unabashed BABA bull. For those who want to own BABA for the long term, the key question for investors on Friday will be whether they play BABA directly or use Yahoo as a vehicle for exposure. I lean toward the former, unless the market values YHOO’s ongoing stake in BABA at less than $.24 for each $1.00 of BABA value.

A version of this post originally appeared on Re/code