Yahoo! Inc. (NASDAQ:YHOO) had a tough start to the week after Pivotal Research made some harsh criticism of the company. Pivotal’s criticism centered around the underperformance of Yahoo core and the notion that YHOO won’t receive what it is looking for in exchange for Yahoo core. That said, it isn’t all doom and gloom for Yahoo stock.
While Pivotal downgraded Yahoo stock from Buy to Hold, its price target of $41 still represents upside of 8%.
That may be good for some, but for others who don’t trust Yahoo management and are buying into the company’s sum of parts investment story, 8% does not do the trick, despite Pivotal making several good arguments as it pertains to Yahoo core’s valuation.
Most who follow YHOO stock know that its core business is not the underlying value driver. It is Alibaba Group Holding Ltd (NYSE:BABA). For that reason, Pivotal is wrong, not its analysis, just where it sees Yahoo stock going.
Why $41 Is Too Low for Yahoo Stock
It is no secret that Yahoo owns 384-million shares of Alibaba stock. That stake is currently worth over $31 billion, and would be equivalent to 80% of Yahoo’s market capitalization if YHOO stock traded at $41-per share. The remaining $8 billion in valuation is tied to Yahoo core, its $7 billion cash position and its investment in Yahoo Japan.
Clearly, the $7 billion in cash nearly wipes out the remaining value at a $41 price target. However, the investment in Yahoo Japan is reportedly worth $9 billion, and according to many media outlets, there were more than 10 bids for Yahoo core valued between $4 and $8 billion.
Nonetheless, bids for Yahoo core have been ongoing for months now, yet there is still a wide disconnect among research firms for what the sale price will ultimately be. Yes, $4 to $8 billion has been floated around as the apparent worth. That’s a difference of $4 per share, which is significant.
That said, Pivotal explains that Yahoo’s market share in global digital advertising has fallen from 20% back in the early 2000s to 3% today, and is still falling. Pivotal realizes that any acquirer likely has a plan to fix Yahoo’s problems, but that’s easier said than done. A company may have second thoughts about spending so much money behind the hopes that it can turn things around.
That’s what makes Yahoo’s upcoming earnings report so important. Analysts expect Yahoo to create $1.08 billion in revenue and earn 10 cents per share when it reports next week. If Yahoo continues to struggle in the key areas that acquirers care about, it could give some pause to the notion of paying $7 or $8 billion.
Granted, there are some reports that Yahoo already received its third round of bids this week, and that an announcement could come with the earnings announcement.
If so, chances are those interested already know the numbers. It is just as likely that bids will reflect whether earnings were positive, especially after Yahoo’s dismal performance last quarter.
Bottom Line on YHOO Stock
The bottom line is that Yahoo stock is worth far more than $41, but just how much is tied to the value of Yahoo core. If you apply a 20% discount to its Alibaba stake — tax-related discount — Yahoo core’s value could determine how much more valuable YHOO stock is over $41, whether it be $45 or $50.
Furthermore, the performance of Alibaba stock plays a big role on Yahoo stock’s future. This is also something analysts seem to forget when setting targets. Fact is that BABA is fast-approaching 52-week highs and has expected growth of nearly 45% this year to push its price even higher.
When it is all said and done, Yahoo stock’s outlook is far better than Pivotal anticipates.
As of this writing, Brian Nichols owns shares of YHOO stock.
