Yahoo! Inc. (YHOO) missed earnings expectations, though it managed to show a year-over-year increase in revenue in the recent quarter earnings call where the management reiterated its plan for the Alibaba spin-off. The huge holding of Yahoo in Alibaba Group Holding Ltd (BABA) amounted to 384 million shares, or $39.5 billion at the time of the announcement. Activist investors were clamoring to know how Yahoo wishes to use its Alibaba holdings and wanted the company to bring forth a tax efficient way of returning this value to the investors.
Solving the Tax Issues
The biggest road block in simply selling its stake was the huge tax liability it would incur. Its earlier stake sale of Alibaba holdings at the time of Alibaba’s IPO in September 2014 reaped a total of $10 billion. However, a total of around 40% was gobbled up by tax leaving less money for the investors. CFO Ken Goldman stated that Yahoo has submitted a request to the Internal Revenue Service for a favorable ruling on the split. Details on the new structure that will hold the Alibaba shares are yet to be revealed.
Yahoo has finally come up with a spin off strategy where 100% of Yahoo’s holdings in Alibaba will be transferred to this new company named SpinCo. Yahoo investors will receive one share of the new entity for every share owned in Yahoo. They can then go ahead and sell their shares which will incur much lesser tax liability. This arrangement provides a defined path on how Yahoo will return $32 billion (based on Tuesday's prices) to its investors. Alibaba can also end up buying SpinCo which will basically transfer the Yahoo shares into Alibaba shares without the tax hit, though Alibaba currently has not shown any inclination to buy it up with its own stock.
Till the final spinoff takes place Alibaba and Yahoo stock will chart a similar price pattern due to the overwhelming value made by BABA stock within Yahoo.
Yahoo had assured its investors that the firm will come up with a low tax alternative. If Yahoo went ahead with simply selling this stake, it would have taken a hit of $16 billion based on $40 billion of valuation of its stake. The lock-in period for Yahoo’s stake in Alibaba was one year from the time of the IPO. That means that this spinoff will take place only in the last quarter of 2015 if there are no hurdles.
It will also spin off Yahoo Small Business, a division which helps small business owners in selling goods online. This division will be attached to SpinCo, so that the newer entity has an operating business which is a must for tax purposes.
Clearing the Way for Investor Profits
This also clears another worry among the investors about the use of the cash. Marissa has followed a high acquisition strategy within Yahoo since she took over the position of CEO. Huge sums of money have been invested in different acquisitions like BrightRoll, Flurry and Tumblr. Although many of these investments will provide good synergy for Yahoo, the actual benefit to the investors will take a couple of years to deliver.
Some of the activists voiced their doubts that Yahoo will use a slice of these returns from Alibaba to power another round of acquisitions. But, now it is clear that the board wants to see maximum value being returned to its investors.
In Yahoo’s Q1 earnings transcript, the company’s management also re-iterated how it has enhanced value for shareholders by repurchasing $9.4 billion worth of outstanding shares since the time incumbent CEO Marissa Mayer took over the reins. Following the spin-off, Yahoo could potentially have returned as much as $41 billion to shareholders.
Focus on Core Business
This announcement puts the focus back on the core business of Yahoo. Yahoo stock analysis reveals a year over year growth in the company with this quarter being the second in last two years to record a positive YoY uptick. The company has continued to show progress in mobile as well. Mobile revenue accounted for about 20% of the total revenue for Q1, up by 17% from Q4 2014, and a growth of 61% year-over-year. Mobile users now stand at 600 million monthly users.
So is the Spinoff Arrangement Wise?
The spinoff arrangement laid out by the management is a highly effective approach of returning maximum value to the shareholders. However, the current news has been priced in within the stock. Any future upside within the stock will be based on how well its core business is managed and would put all focus on the efficacy of Marissa’s strategy of shifting Yahoo to mobile and social platform to generate higher growth.