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Yahoo Needs To Turn Itself In To An OTT Play To Save Itself

This article is more than 8 years old.

[Long YHOO]

I've been a Yahoo shareholder off and on - mostly on - since 2006.

I haven't been always right in my assessment of the company. I had complained about the pace of improvement under former CEO Carol Bartz. Now, any Yahoo shareholder would give anything for half the growth that was exhibited then. But, overall, I think I've been more right than wrong. And, of course, they say that good judgement comes from experience which comes from bad judgement.

At present, Yahoo is drifting. Investors - those left - are not quite sure what it is.

I know what it used to be. It used to be a huge destination in the PC age. At one point, a billion people came to Yahoo on desktops every month to get their info.  More than eighty percent of its revenues still comes from PCs even today.

Although it's trying to reinvent itself in the mobile age, it hasn't been successful. Answer this simple question: What Yahoo apps do you have on your phone? That's the problem.

Although Yahoo tries to trumpet its growing mobile numbers, they are not that impressive, especially compared to Facebook's.

Imagine if you started with a billion PC users three years ago and you're running Yahoo. Do nothing for the next 3 years except sit in your cubicle.

How many of your billion PC users would try to access their Yahoo email from a mobile device in the next 3 years? Probably a decent ratio. Now trumpet those users as evidence that you're the fastest growing start-up in Silicon Valley. That's essentially what Yahoo has done.

In the past three years, revenue and profits (EBITDA) are down, while costs have gone up.  Even though it's been trying to shed headcount quietly in the past few quarters, Yahoo still employs more than Facebook even though it's a fraction of Facebook's size.

You put this all together and Wall Street has a dismal view of Yahoo's core business, which is of course the future of Yahoo after it sheds its Asian stakes.

Today, Yahoo's market capitalization is almost $29 billion. They have net cash of about $5.5 billion. Their 384 million shares of Alibaba are worth about $26.2 billion untaxed or $16.2 billion fully taxed. Their Yahoo Japan stake is worth $8.3 billion untaxed or $5.1 billion fully taxed.

In the untaxed scenario, these cash and stake assets add up to $40 billion, implying that Yahoo's core business is worth -$11 billion. In the fully taxed scenario, these cash and stake assets add up to $26.8 billion implying that Yahoo's core business is worth $2.2 billion for a business purportedly doing about $1 billion a year in EBITDA.

That implies Wall Street believes Yahoo's core biz - in the most conservative scenario - is worth 2.2x its EBITDA. AOL was recently acquired by Verizon for 7x its EBITDA.

What if Yahoo had a plan with competent management and backers? What if the plan was to build something new that had a reasonable chance of success while milking the existing business for as long as it can?

Yahoo should turn itself into an alternative Over-The-Top video subscription channel that competes against Netflix, Amazon, and Hulu. There are few places to subscribe to unique premium content online today. Although big cable bundle channels could go direct themselves, I've written previously about how difficult it will be for them to do so and turn their back on the bird-in-the-hand bundle affiliate revenues.

At the same time, Yahoo has a widely recognized brand both domestically and internationally.  If they launched an OTT offering, it would arguably be better recognized right away than even Hulu which has been around for years.

What content would Yahoo offer? It would have to be more than just Community episodes. Yahoo already produces a lot of content today. It could do new content around some of its home-grown talent like NBA expert Adrian Wojnarowski. It could do some innovative content around e-sports or Daily Fantasy where it just launched a product.

However, it would probably have to cut deals. CBS - not part of Hulu - could be approached. They're always looking to make more money from licensing out their content. The old cable bundle people could be interested in that approach too.  Maybe no one wants to pay $10/month for HGTV direct-to-consumer as a stand-alone service, but they would like bits and pieces as part of an overall Yahoo direct offering.

Yahoo should look to green-light its own original content over time as well, like Netflix and Amazon.  I hear Jon Stewart is available to do whatever content he wants. What about Howard Stern? Lots of people would pay $10 a month to see that.

There are very few people who already have a spot on Apple TV's list of "channel" offerings. Yahoo is already there. They should make the most of it, instead of frittering away the opportunity as they did when they got booted off Snapchat Discover a few weeks ago because their content was dishwater dull.

To execute this strategy most effectively, Yahoo would likely need new owners and a new leader.

The Chernin Group, AT&T and Providence Equity tried to buy Hulu before its owners took it off the market. Why not try to buy Yahoo's core business.

How could they do this? Make an offer to buy the whole business? That would be complicated as Yahoo is in the midst of trying to shed its Alibaba and Yahoo Japan stakes.

Instead, these investors could simply buy up 5% of Yahoo's shares on the open market. At today's prices, it would cost them about $1.5 billion. Back in 2013, the Hulu bidders were apparently willing to bid $1 billion for the site.  Owning 5% of Yahoo would make them much larger shareholders than Starboard Value LP was last September when they called for major changes at the company.

After buying up the shares, TCG/AT&T/Providence could then let the world know that they're seeking control of Yahoo's board of directors when they come up for election next June (or later if Yahoo's board stalls).

We're then in a political style election campaign where the new investors have to make their case for why their plan will be more successful than the status quo plan.

Let the shareholders look at the options and vote and may the best plan win.

I would imagine the TCG/AT&T/Providence plan would talk about taking down the costs of the legacy business which would involve a lot of cost cuts. There are 12,000 people working at Yahoo right now building Livetext and other stuff. 12,000. Facebook employs 9,000 people.

If you cut about half the product and general and admin costs out of the company, that's $1 billion there that drops to EBTIDA annually. So now Yahoo's EBITDA is $2 billion a year instead of one for the legacy business. Let's say that, with competent management, it should be valued at 5x which is a discount to AOL's 7x. That means the legacy Yahoo is worth $10 billion.

Then you outline your OTT plan. Here's how we get to 10 million subs by some realistic date in the future. This is the content we're going to get. This is our distribution plan. Here's why people are going to want to work with us. Here's why it will win domestically and internationally.

What's that new business going to be worth? Well, it's going to be worth more than zero. Maybe it's valued by public market investors at $500 million right out of the gate. Investors are also going to fully value the $5.5 billion in cash on the balance sheet. That's what you're going to use to go get some good content to get your subscription business going. In the meantime, you're going to call on the old management to stop wasting money on Tumblr-type and style site M&A.

Who could run this new Yahoo? There are lots of people. If I was Peter Chernin, I'd go to Jason Kilar and say he should quit Vessel, keep his equity, and come run the most exciting OTT play around. If he says Yahoo needs to buy Vessel for $500 million, that's probably too steep.  There are other options.

Why not get new TCG Digital President and ex-Yahoo exec Mike Kerns to run the new company? He likely knows where all the fat can be cut.

Of course, the TCG/AT&T/Providence pitch would also include finding a way to dispose of the Alibaba and Yahoo Japan assets in the best way possible so that Yahoo core can truly trade on its own merits instead of being knocked around based on what's going on with Alibaba and China.

How could Yahoo investors say no to this credible plan?

By this time next year, the new investors would take over running Yahoo's board and start implementing their changes in a very orderly transition.

And how would their $1.5 billion investment do? Well, in the upside scenario: old Yahoo is worth $10 billion, new Yahoo is worth $500 million, their cash is $5.5 billion, the Alibaba stake gets sold back to Alibaba at a 10% discount untaxed making it worth $23.6 billion. And Yahoo Japan gets sold back to SoftBank at a 10% discount untaxed making it worth $7.5 billion.

The total value of Yahoo under new management? $47.1 billion or $50/share.

What would the TCG/AT&T/Providence 5% stake be worth? $2.4 billion. Up from $1.5 billion. And that's with your new Hulu 2.0 network being valued at basically zero today before you build it up.  You've created this increase in value just from having a realistic plan that can win.

The alternative plan would probably discuss investing the remaining $5.5 billion in new mobile search and texting products as a way to supplement the core Tumblr GIFs and Flurry analytics.

The bottom line is that this is a plan that can win. It's good for Yahoo investors, Yahoo employees, Yahoo users, Yahoo partners and new investors. It should be an easy sell for investors.