Even though activist investor Starboard Value owns less than 1% of Yahoo! (YHOO) stock, the firm has been quite vocal. This week, Starboard sent a letter to YHOO CEO Marissa Mayer with a list of recommendations, including the idea for YHOO to acquire AOL (AOL).
Ultimately, these recommendations — some of which felt more like ultimatums — may prove to be bad news for YHOO stock.
But as should be no surprise, AOL stock has been pumped up this week, gaining about 9%. It also helped that there were rumors that Verizon (VZ) was thinking of buying the company or forming a joint venture. But the CEOs of VZ and AOL have since denied the buzz.
Still, it’s worth considering whether Yahoo has anything to gain from an AOL merger.
Why Starboard Likes a YHOO – AOL Deal
Jeffrey Smith, managing partner at Starboard Value, thinks it would be a big mistake for YHOO to buy a cable network like Time Warner’s (TWX) CNN. He also does not like the chatter that YHOO is considering a so-called “cash-rich split-off” structure to separate its minority assets, such as in Alibaba (BABA) and Yahoo! Japan. Smith is convinced that the tax costs and complexities would be a loser for Yahoo stock.
Smith also complains that YHOO needs to “significantly reduce costs to improve profitability in its core business.” Interestingly enough, he thinks a combination with AOL would help. Smith expects cost synergies of anywhere between $1 billion to $1.5 billion and a spin-off of minority assets to be more tax efficient. Finally, YHOO would get the benefits from some of the growth of AOL, such as its video advertising platform and mobile apps.
Nor does Smith shy away from the consequences if YHOO fails to consider Starboard’s recommendations. According to his letter: “Should you instead choose to proceed down a different path by pursuing large acquisitions and/or a cash-rich split, both of which have been speculated, such actions would be a clear indication to us that significant leadership change is required at Yahoo.”
Ouch!
No doubt, when it comes to dealmaking, it always looks good on a spreadsheet. So with a combination of AOL and YHOO, there would likely be sizeable cost synergies (hey, it’s never hard to cut costs!) There may even be tax benefits.
The Downside of a YHOO Deal
But all the benefits could still be wiped away. The reality is that transformative mergers are always tough. In a merger of AOL and YHOO, the layoffs would be difficult to say the least and the integration issues would be daunting. The distractions could make it tougher for YHOO to compete against mega players like Facebook (FB) and Google (GOOG).
There are also many emerging operators, like Snapchat, that will probably get a bigger piece of the advertising pie. Besides, AOL is still a lumbering company, with revenue growth at about 11%. AOL continues to be weighed down by legacy businesses like the Internet dial-up service.
Besides, the acquisition history at YHOO has been lackluster over the past couple years, which has included dozens of smaller deals and several large ones like Tumblr. But the revenue growth has remained stagnant. In the latest quarter, it was a measly 0.8%. Putting this in perspective, Google posted revenue growth of 20% in the same period and Facebook’s was a sizzling 59%.
For the most part, the recent success YHOO stock — up about 44% during the past six months — has much to due with the company’s 15% stake in Alibaba. However, BABA has recently stalled and unfortunately, YHOO’s core business is still stuck in neutral.
Buying a mature operator like AOL probably won’t get things back into gear.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
