by Will Ashworth | May 16, 2014 10:47 am
Today we know Berkshire Hathaway (BRK.B) as an incredibly successful conglomerate with business interests spread across many industries. But Berkshire Hathaway began life as a terrible investment in a fading textile business. The name stuck … but that was about it.
The difference-maker for Berkshire? Arguably it’s Geico, the second-largest auto insurer in the U.S. behind State Farm. Buffett paid approximately $2.4 billion for the entire company (obtained the remaining 49% in 1995) that today is valued at $14 billion.
What does that have to do with beleaguered tech giant Yahoo (YHOO), which seemingly warrants absolutely no comparison to Berkshire Hathaway?
Well, thanks to one of its holdings, Yahoo and Marissa Mayer do have the unthinkable opportunity to take the company down a similar road as the one walked by the Oracle of Omaha.
The Alibaba IPO is expected to be the biggest of the year — and possibly ever. Some estimates put Alibaba’s value at as much as $245 billion, making Yahoo’s 24% stake in this scenario worth $58 billion — $23 billion higher than the entire market cap.
However, under the September 2012 repurchase agreement with Alibaba, Yahoo is obliged to sell up to 208 million shares in the Alibaba IPO. If it sells the full amount, Yahoo’s ownership stake would be reduced to 14.5%, or a more meager $35 billion — very close to the Street’s current valuation of YHOO stock.
Point being, it’s an impressive stash, even in the most conservative valuation scenario.
The problem — as InvestorPlace editor Jeff Reeves so ably points out — is that there’s no value in the rest of Yahoo’s business. According to Jeff’s math, the rest of Yahoo excluding its stakes in Alibaba and Yahoo Japan (YAHOY) was worth negative $9 billion at the end of March. Based on the optimistic $245 billion valuation of Alibaba, Yahoo’s remaining businesses are now worth negative $34 billion, considerably less than just six weeks ago.
So, what’s Marissa Mayer to do?
Well, if she’s read anything about Warren Buffett, she’ll know that his biggest regret was spending so much money trying to plug a leaking boat — in his case, it was Berkshire Hathaway — when he could have invested those funds in other insurance companies. He figures it cost shareholders about $200 billion. Quite an admission from someone so successful.
Rather than continuing to buy money-losing businesses like Tumblr, which cost the company $1.1 billion in cash and has done little to help Yahoo compete in online media, why not consider getting out of the business altogether?
Heed the advice of an investing guru and let your winners ride. Berkshire Hathaway shareholders have been handsomely rewarded as a result.
Let’s assume Alibaba continues to shine (and there’s no reason to think it won’t). If so, Mayer should use its Alibaba stake as the foundation for a new company investing in tech companies — and also non-tech companies that utilize technology as a competitive advantage — that are profitable or soon will be.
Like Berkshire Hathaway, it would have a component made up of private companies, as well as a portion dedicated to stocks like Alibaba and others.
Consider for a moment that this new company would have a market cap double that of another respected conglomerate — Loews (L) — capable of making some very big acquisitions. The new business’s mandate will be to deliver an annual return on invested capital of 10%. It wouldn’t be easy. Berkshire Hathaway has averaged 6.8% annually over the past five years. So perhaps 10% is far too optimistic … but even half that still is better than Yahoo’s current situation.
In the first quarter, YHOO operating income declined 84% to $30.2 million on $1.1 billion in revenue. Diluted earnings were 29 cents per share. Without the gains from Alibaba and Yahoo Japan, its earnings would have been less than 2 cents per share.
Continuing to incur such meager returns will only hurt existing shareholders.
Yahoo does have a couple other ways it could go.
The first is for Yahoo to pay a special dividend from the cash it will receive for the shares it sells in the Alibaba IPO. Gross proceeds could be as high as $23 billion (selling 9.5% stake at $245 billion valuation), which amounts to $22.60 per share given 1.03 billion shares outstanding at the end of Q1 — a whopping 66% yield based on its current share price.
You could do that … but YHOO stock likely would crater shortly thereafter as investors take their money and run.
A second option is for Yahoo to buy more businesses that will help it compete in online media. But that’s a losing proposition that will only squander the huge payday Yahoo has generated from Jerry Yang’s brilliant $1 billion investment in Alibaba back in 2005.
Forget about trying to run with Google (GOOG) and all the other big dogs out there; simply make better investments in companies that other people run.
Just like Berkshire Hathaway does so successfully.
No, the best option (in my opinion) is to create a new company that would hold the remaining shares not sold in the Alibaba IPO. With an optimistic $245 billion valuation, those shares would equal the market cap of Yahoo, so it wouldn’t be unreasonable to issue new shares on a 1-for-1 basis. Yahoo would then turn around and lend the new company $23 billion or whatever amount it receives from the Alibaba IPO.
The move would provide a decent amount of income to Yahoo while it seeks to find a buyer for both its Yahoo Japan stake and its core operations. The risk is Jeff Reeves and others are right about its core operations having no value. The reward is exactly the opposite.
And what’s in it for Marissa Mayer?
Assuming she pulls it off, she’ll get credit for finding a buyer for the part of the business nobody thought was worth anything. Second, and even more important, she’ll be able to run the Berkshire Hathaway of the tech world. These two achievements would cement her status as an icon in the tech sector while successfully extricating Yahoo from an impossible position.
Not quite Houdini — but close.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
Source URL: http://investorplace.com/2014/05/yhoo-alibaba-ipo-berkshire-hathaway/
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