When Yahoo (YHOO) turned down Microsoft’s $44.6 billion buyout offer in 2008, many pundits wondered whether the pioneering Internet media company would ever reach such lofty heights again.
It only took 5 years to prove the naysayers wrong, but investors shouldn’t be fooled by the stock’s recent surge, which is the solely the result of Wall Street’s enthusiasm for the company’s 24% stake in the high-flying Chinese Internet company Alibaba — not a sign of confidence in Yahoo’s growth prospects.
It’s basically a sugar high that will come crashing down at some point, though when that will happen is tough to say.
The Alibaba investment was the brainchild of former “Chief Yahoo” Jerry Yang, whose disastrous tenure as CEO was highlighted by the company’s decision to turn down Microsoft’s offer. Yang was shown the door and Wall Street has declared his tenure to be a dismal failure. Ironically, though, Yang’s work could end up being wildly profitable for YHOO stock.
According to a recent note from Stifel Nicolaus, Alibaba’s valuation at the IPO could be an astounding $120 billion and will increase to $200 billion after the second tranche which could add about $10 to YHOO stock if the company can distribute its shares tax efficiently, which it sees as a 50% probability.
The growth in Alibaba, founded in 1999 by Jack Ma in his apartment, has certainly been remarkable. Based in the Chinese city of Hangzhou, Alibaba been likened to Amazon (AMZN), though that doesn’t tell the whole story. Its Taobao operation is China’s largest online marketplace with 800 million listings from 7 million merchants, mostly small businesses. Another site, Tmall, connects large, international brands with Chinese consumers.
Alibaba’s 2012 sales were $170 billion, surpassing Amazon and eBay combined. On the Nov. 11 Chinese holiday, Alibaba’s sales rose 87% to $58.billion, more than twice what retailers sold in the U.S. jointly on Black Friday and Cyber Monday. Management at Alibaba are not shy about making bold predictions, including a plan to triple transaction volume last year and overtake Walmart (WMT) as the world’s largest retailer by 2016.
Those metrics are certainly impressive, but they obscure the fact that the core business at YHOO is withering. Display advertising revenue slumped 7 percent to $470 million during the most recent quarter, and Yahoo’s share of the overall market slumped to 7.7% while Google (GOOG) and Facebook (FB) posted gains. CEO Marissa Mayer has tried to jumpstart growth through acquisitions, as with last year’s $1 billion deal for the popular blogging site Tumblr and an overhaul of the company’s services to make them more user-friendly.
YHOO stock is priced as if there will be nothing but blue skies ahead for Alibaba and the Chinese economy, but in reality there are storm clouds brewing on the horizon. As David Magee recently noted in the International Business Times, inflation is on the rise and many expect the country’s red-hot real estate market to burst. Said Magee:
“… China has become more economically westernized through its growth period than what it once was. The more it mingles financially with the rest of the world, the harder it will be for the government to falsely buoy a bust.”
China has also got a government debt problem at the local government level, and banks have tripled their bad debt write-offs in the sector as a result. The Wall Street Journal has some pretty scary figures, including the fact that Chinese debt has soared to 198% of GDP versus 125% on 2008. Meanwhile, GDP growth has slowed to 7.5 percent in 2013 — a far cry from the double-digit levels seen in the past.
The hype around Alibaba is understandable. Net income in the latest quarter more than doubled to $707 million from $273 million a year earlier. Revenue jumped 60% to $1.73 billion. YHOO bulls, though, have to ask themselves what would happen to Yahoo’s “Secret Weapon” if Alibaba begins to falter. Given the uncertainties surrounding the China economy, that isn’t far-fetched.
Until the situation becomes clearer, investors should steer clear of YHOO stock.
As of this writing, Jonathan Berr did not hold a position in any of the aforementioned securities.