Verizon Can Say NO to Yahoo

Verizon can still say “NO” to Yahoo. While Yahoo finally agreed to sell its online assets to Verizon, the two parties will still be connected, at least through Yahoo Japan. As Yahoo becomes Altaba, essentially an investment fund, Verizon still has a say in the Yahoo Japan shares that comprise part of the value of Altaba.

Altaba can’t easily sell its Yahoo Japan shares. First, if the Yahoo Japan shares were sold, then there would be high tax bill and Altaba would return less cash to investors.  Secondly, due a joint venture agreement between old Yahoo and Softbank, Altaba can’t freely sell the Yahoo Japan shares without involving Softbank; if Altaba did decide to sell the Yahoo Japan shares, then Softbank would have the right to first buy the shares.

Now a third roadblock, if Altaba wants to sell Yahoo Japan shares, it will need the consent of Verizon.  As stated in stock purchase agreement…

….the Fund may not, without Verizon’s consent, to the extent within Yahoo’s control, and except as may result in a violation by the Fund or any of its directors, officers, or employees of applicable law (including fiduciary duties) sell its shares in Yahoo Japan or consent to an acquisition of Yahoo Japan or all or substantially all of Yahoo Japan’s assets if such action would reasonably be expected to cause the termination of, or give Yahoo Japan the right to terminate, the license agreement between Yahoo Japan and the Company

Yahoo Investors Get Less

Yahoo accepts a lower valuation for its online assets from Verizon due to recent security breaches. Verizon will reportedly pay between $250 million to $350 million less than the amount agreed upon last year.

At that time, Yahoo expected to receive $4.8 billion, but now Verizon will pay about $4.4 billion. After paying taxes of $145 million on the gain from selling the online assets, Yahoo shareholders may eventually get $4.3 billion or $200 million less based on the prior valuation.

David Karp, Gone Fishing

Is Tumblr Founder, David Karp, sticking around? Marissa Mayer is definitely hanging out a little longer. On Monday, Yahoo said this about the Verizon Sale:

However, given work required to meet closing conditions, the transaction is now expected to close in Q2 of 2017. The company is working expeditiously to close the transaction as soon as practicable in Q2.

Included in the online assets going to Verizon is Tumblr. Marissa Mayer, some say, inherited some very bad problems at Yahoo, but the Tumblr acquisitions was all hers.  At the time of the acquisition, it was described this way by Yahoo:

Our acquisition of Tumblr in Q2 2013 is an example where we gained access to an engaged community of younger users that complemented our core audience.

Tumblr investors received about $1 billion in cash and stock. For Yahoo, its investment didn’t turn out as planned. Yahoo was not able to monetize the traffic coming from Tumblr, causing Yahoo to eventually write off the premium paid for Tumblr. Yahoo didn’t necessarily overpay, it just wasn’t able to achieve its reasons for purchasing Tumblr.

In the Tumblr acquisition, David Karp got an employment contract. Each year he received $10 million in cash and $10 million Yahoo stock as long as he remained an employee. The four year contact ends this year and presumably in June.

Yahoo expects the Verizon sale to close in the second quarter of 2017. Afterwards, Verizon owns Tumblr, but will it have David Karp, too?

 

 

 

Alibaba is china

Time to reflect upon this: Softbank is working hard, putting together another investment fund, the Vision Fund, to replicate prior successes like Alibaba.

A small investment in Alibaba, made about fifteen years ago by Masayoshi Son, is now worth many, many billions.  Only Yahoo’s Jerry Yang had the same “luck” when he invested in Alibaba a little over ten years ago. Yang’s investment has grown to overshadow the worth of Yahoo’s other operating businesses.

Alibaba’s public stock offering provided an opportunity to cash out for Yahoo and Softbank. Last year, some of Softbank’s Alibaba shares were sold for $10 billion in order to pay down debt and strengthen the balance sheet. Softbank still owns about one third of Alibaba.

Yahoo doesn’t own a third of Alibaba, but still has a substantial ownership. Like Softbank, Yahoo sold some Alibaba shares; this time, the sale was in 2014 and by Marissa Mayers. Unlocking value in the remaining Alibaba shares, the machination of Starboard Value’s Jeffrey Smith, has lead to selling of Yahoo‘s online business to Verizon.

What would happen if Jeffery Smith and Masayoshi Son were wrong? That Alibaba isn’t worth so much. Then they wouldn’t need to worry so much. For example, Naspers small bet on Tencent is now worth many, many billions, leaving current the CEO with an “existential crisis” of his next bet.

In these euphoric times, Alibaba may not be that high. Famed short-seller, Jim Chanos did have a short position on Alibaba as of last year. His shorting thesis is that Alibaba’s true earnings are obscured by the use off-balance entities. His trade may be wrong, but what is right is understanding the importance of Alibaba’s value to Softbank and to a lesser degree, Yahoo.

It’s not china, but with Alibaba, we must be careful, because it could break.

 

Exit Marissa, What’s Next for Yahoo.

What happens next to the newly named Altaba after the departure of Yahoo directors, Marissa Mayer and David Filo? Altaba itself gives a description of things to come: a company that is an ALTernative to AlibABA. Ahead are more asset sales, so that all that remains is Alibaba stock.

Game Plan 

After the Verizon sale, the remaining board  – Tor Braham, Eric Brandt, Catherine Friedman, Thomas McInerney, and Jeffrey Smith – will have the talent for turning the old Yahoo into a closed-end investment fund. Getting there will still require work and financial expertise.

Inside the old Yahoo is stock with unrealized gain, patents, and cash. The end game is removing these assets so only the Alibaba shares remain. Then the Alibaba shares can either to sold to Alibaba or transferred to Alibaba in a merger. Merging with Alibaba would be a tax-free method for getting the shares out of Altaba.

Cashing Out 

Jeffrey Smith’s Starboard Value LP owns 12 million Yahoo shares that are worth approximately $550 million. As board member and investor, Mr. Smith has very incentive to maximize the value of Altaba shares. So if Mr. Smith’s real goal is not a closed-end investment fund, but something that is an alternative to owning actual Alibaba stock, then the other assets must go.

Hopefully Yahoo will be successful with the sale of its online assets to Verizon for $4.8 billion. The next step will then be returning the cash to shareholders through dividends or stock repurchases. Remaining board members should be astute enough to return cash through buying back stock since it is more tax efficient for shareholders than dividends.

Maximize Value

Eventually the patents will need to be sold along with the Yahoo Japan stock. But the Yahoo board does not intend to sell the Yahoo Japan, which at first makes sense. The Yahoo Japan shares were purchased for $2 billion and are currently worth around $16 billion. So after selling the Yahoo Japan shares and paying the tax bill, only $10 billion of cash would available for shareholders.

It does make sense to sell the Yahoo Japan shares to achieve an ALTernative to AlibABA. In fact, in the same proxy statement, the board said it …. currently believes that it is more likely that capital may be returned from a sale of Yahoo Japan Shares than Alibaba Shares. Remember selling either the Yahoo Japan or Alibaba shares would result in large tax bills, but the goal seems to be leaving Altaba will only Alibaba shares.

Yahoo’s market value is still less than the sum its underlying assets. Remaining board members, especially Mr. Smith, will continue to do anything to maximize shareholder value; something Marissa Mayer and David Filo were not able to do.

 

Trump Saves Yahoo, Not You?

Trump’s intent to slash the corporate tax rate could help many tech companies, especially Yahoo. Like regular people, corporation pay taxes on income and Yahoo has assets, which, if sold are subject to the currently high corporate tax rate. Lowering the corporate tax rate would mean more money for Yahoo and less for the Government.

High corporate tax rates have already caused Yahoo to pay a lot to the Government. Back in September 2014, after Marissa Mayer sold a portion of Alibaba shares, Yahoo paid $3.3 billion in taxes to the Government on a $9.4 billion sale. This left shareholders with only $6.1 billion; that amount would have certainly been more under Trump’s corporate tax rate.

Unlocking

Trapped inside Yahoo is not only Alibaba shares, but shares of Yahoo Japan. Getting the Alibaba and Yahoo Japan shares out of Yahoo, without incurring a large tax bill, has vexed many managers. Not only does Yahoo pay taxes on any gains, but the gains are taxed again when distributed as dividends to shareholders. This is why activist investor,  Starboard Value, looked for tax-free ways to get the assets out of Yahoo.

One method tried was not to sell the Alibaba and Yahoo Japan shares, but to distribute the shares to Yahoo shareholders in a tax-free spin-off. When that didn’t work, Starboard Value proposed the sale of Yahoo’s online business with the Alibaba and Yahoo Japan still trapped inside Yahoo. With the online business gone, the true value of the Alibaba and Yahoo Japan shares should be realized.

In July 2016, Yahoo proposed selling the online business to Verizon for $4.8 billion.  If Verizon could wait, then Yahoo could save money. As with the Alibaba stock sale in 2014, Yahoo will owe taxes on the sale of the online business. Yahoo is selling the online business for $4.8 billion and the online business has a value of $4.1 billion to Yahoo.  Thus the gain on ‘this’ sale is $700 million. Yahoo estimated the tax bill on the sale to be $290 million; that amount would be $140 million under Trump’s lower tax rate.

ALTernative AlibABA

After the sale, Yahoo will be replaced by Altbaba. The new name could be a play on “ALTernative AlibABA” because the newly named company will hold the remaining Alibaba shares. Altaba will also have the Yahoo Japan shares, patents, and cash. Over time, the cash will be distributed to Altaba shareholders as either dividends or tax-efficient, stock repurchases.

Altaba’s stated goal is tracking the “combined investment return of the Alibaba Shares and the Yahoo Japan Shares”. Tracking is not assured since Altaba will include other things such as the patents and tax liabilities. Yahoo estimates it owes the government $12 billion in taxes if the Alibaba stock was to be sold. So the ultimate value of the Altaba is the market value of Alibaba shares ($31 billion) and Yahoo Japan shares ($3 billion) less the tax liabilities ($12 billion). Based upon numbers released in a September 2016 proxy, that amount would be $22 billion.

Altaba shareholders could benefit from Trump’s lower corporate rate. A lower corporate rate would cut in half the estimated tax liability on the Alibaba shares. Instead of tax liabilities of $12 billion, the new Altbaba would only owe taxes of about $6 billion. The lower tax liability would increase Altaba’s value from $22 from $28 billion.

Conclusion

Trump proposed corporate tax rates may not change the timing and structure of the Yahoo’s proposed transactions. But for Yahoo shareholders the lower tax rate may impact value of their investment.

Disclaimer: Post intended only for information and not for investment purposes.

 

Yahoo’s Verizon Tax Bill

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Last month, Yahoo announced the details of its sale to Verizon in a proxy statement.

Kara Swisher, of Recode fame, said of the proxy:  “It’s a pretty dry document, written by lawyers for lawyers about how shares will be distributed and what goes where”.  Yet for Yahoo investors, the proxy told more: the taxes dues from the sale.  

The  sale was a workaround to separate Alibaba stock in tax efficient manner as stressed by Jeffrey Smith of Starboard Value. The first method attempted was a tax free spin-off of the Alibaba shares to shareholders.

After the IRS blocked that pass, Starboard encouraged the reverse: sell the operating business and leave investors with the Alibaba stock.

As reported, Verizon will pay $4.8 billion in cash to Yahoo for stock in a subsidiary holding the operating business. To Yahoo, the stock is worth $4.1 billion. So the taxable gain from sale was $700 million.

Yahoo will owe $287 million in State and Federal taxes, after slapping estimated tax rate of 41% on the $700 million gain. The remaining cash of $4.5 billion will go to the existing shareholders of Yahoo.

 

The Day Yahoo Died

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October 23, 2005 is when Yahoo acquired a stake in Alibaba. A year before, Google had gone public and, rather than invest in others, Google was investing in itself. Yahoo co-founder, Jerry Yang engineered the acquisition of 46% of Alibaba, but that deal may have marked the end of Yahoo. For afterwards, one company thrived and the other did not.

Google thrived by outspending Yahoo in terms of capital expenditures. Companies, like people, grow by reinvesting in themselves. You can earned more with an education, so you invest money and time in acquiring one. Companies spend money on capital expenditures which allow them to expand their business, so in the future they can receive increased cash flows from operations.

Google spent three, four, five, and finally six times the amount Yahoo was spending on capital expenditures during 2005 to 2010.  Spending only slowed after the Lehman Shock of 2008 for both companies, but Google still spent twice as much as Yahoo as shown in Chart I. In 2005, Google spent $800 million and five year later was spending $4 billion on capital expenditures.

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Source: Annual Reports

It’s difficult knowing where the money was actually going, though.  In its 2005 Annual Report, Yahoo said it purchased “information technology assets to support our expanding offerings, our increased number of users and our international growth.” While in same year, Google disclosed it spent partly for “information technology infrastructure….”

Then a secret, but now more better known, Google was quickly building and leasing lots of data centers. In 2008, Nicholas Carr would explain Google’s technology strategy in the The Big Switch. Google’s then business strategy is even simpler to explain here: build data centers to spend search inquires, attract users, sell ads and then repeat.

Google beat its rivals in search and increased its operating cash flows. In 2005, both Yahoo and Google earned approximately $2 billion from operations. But afterwards, Google’s cash flows increased two, three, four, and five times from the level set in 2005. In 2010, Google cash flows were now $11 billion. By comparison, Yahoo’s cash flows from operations in 2010 were lower, not less than zero, but $1.2 billion as shown in Chart II.

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Source: Annual Reports

Yahoo did not reinvest in its core business in the same way as Google. Yahoo did spend $1 billion and its China properties for a piece of Alibaba. Yahoo’s Alibaba investment has paid off and now represents most of Yahoo’s value. And after Yahoo sell its core business, patents, and other assets, the Alibaba stock will be all that remains for shareholders.

Yahoo could have spent $1 billion in other ways, but did not. Google said back in 2005 that “investments in our business are generally made with a focus on our long-term operations”. Yahoo fell behind long ago, because it didn’t keep up and move ahead. And that all began on October 23, 2005.

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