Trade of the Day: Yahoo (YHOO)

If you can't beat 'em...buy 'em

   

Yahoo! (YHOO) has struggled to improve its legacy business, trim down, access mobile audiences, and compete with the giant that is Google (GOOG). It lagged the 2009 bull market considerably as management failed to find a direction. However, now YHOO is turning things around and is making a compelling argument for future growth through acquisitions and improvements in user engagement.

If cash is king, then YHOO is in a very interesting position to unlock the value of their audience and market share in the near term through acquisitions and internal growth. There will always be a lot of risk in a scenario like this and the run-up in the stock’s price this year has already been robust, but we feel that investors are still underestimating the stock’s potential.

Can Captain Mayer Turn the Ship Around?

The market has been willing to price in future performance following the “acquisition” of CEO Marissa Mayer from Google. The stock is up almost 70% following that coup and investors have a lot of confidence in this superstar manager. However, like we have seen recently with Ron Johnson’s J.C.Penney  (JCP) debacle, a big name at the helm does not automatically translate to success.

The biggest differences we see between recently failed turnarounds (like JCP) and YHOO is their relative capital position and access to the right audience. For example, one of the most significant sources of additional capital for YHOO is in the form of their ownership in Alibaba (the largest internet company in China) that is currently planning a $60 – $70 billion IPO in Hong Kong in the near future. If YHOO sells its remaining 20% stake in the business, that will be a windfall for growth and buy-backs, and growth could skyrocket.

YHOO Embracing New Audiences: the Good, the Bad and the Ugly

YHOO has already made a move to compete with Twitter and Facebook through their pending $1.1 billion acquisition of Tumblr – a microblogging and social network platform with over 108 million blogs. Analysts are mixed about this acquisition because, unlike Facebook, accounts are anonymous and revenue has been slow in developing. Tumblr is not really set up for advertising yet, and that will be a big hurdle to overcome. The company made a mere $13 million in 2012 and is expected to make $100 million in 2013 in advertising revenue and fees. Can YHOO make more from 13 billion monthly page views than Tumblr’s management can? Yes, and probably by a much wider margin than most investors are expecting — so why all the skepticism?

We believe Tumblr represents the kind of pragmatic acquisition that Mayer and team will continue to make but analysts have a hard time valuing. Tumblr gives them access to a massive audience, 108 million blogs of user-generated content, and access to the social networking market, but it also comes with what some analysts consider a liability that makes it very different than competitors like Youtube, Facebook (FB), or Twitter.

Tumblr is well known for hosting blogs with…ahem…“mature” content and the audiences that come with it. No one wants to be the analyst that says this is a competitive advantage and a differentiator, but let’s face it – it is. If you don’t like this kind of content – don’t buy the stock, but don’t bet against it either. We aren’t suggesting that homemade porn is going to make this acquisition profitable on its own. Rather we think that the “unlimited” nature of Tumblr (the good, the bad and the ugly) is more in line with where Internet audiences are headed and where they will continue to migrate.

Since the Tumblr acquisition, YHOO has announced a play for Hulu (still very early in that deal) and acquired mobile gaming platform PlayerScale last week, a deal slipped under the radar. PlayerScale gives YHOO access to mobile gaming and 150 million users. According to ComScore, over 30% of the time spent on mobile devices is on games, vs. 18% on Facebook and 20% on browsers, so this buy seems to have potential. When you look at just these three deals together, the scheme becomes a little clearer. In addition to building new audiences and increasing user engagement, YHOO is trying to change its demographic.

The majority of Tumblr, PlayerScale and Hulu users are under the age of 35 while the same cannot be said of YHOO’s traditional properties. Shifting the demographic like that should be accretive because YHOO’s older audience is still there and likely to remain. The question is whether or not the revenue from the new audiences and platforms will be worth the acquisition expense? It’s fair to ask and only time will tell, but in a market where so many other firms are scared to spend capital for growth we think it’s worth the risk.

How to Trade YHOO

We are currently targeting $30-$35, but a break below $25 indicates a higher likelihood for a stronger correction and long positions should be covered in that scenario. Trading will be choppy while traders try to settle on an appropriate valuation of the Tumblr acquisition and the Hulu deal develops (or doesn’t) so a long call option position may be preferable in this situation.

Recommendation: Buy YHOO at current prices with a $30-$35 short-term target.

Options Alternative: Buy to open the August $26 Calls for $1.50 per share or less.

InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.  Get in on the next trade and get 1 free month today by clicking here.


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