[Disclosure: Author was long YHOO at time of writing.]
There’s been a sharp response to the post I wrote last Wednesday in Forbes outlining the rationale for either Alibaba or SoftBank buying Yahoo at current levels.
The stock is up 6.5% since that story first was published on heavy volume.
To me, the strong response by investors to the story suggests one thing to me loud and clear: investors would rather get all of the cash coming back to Yahoo from the pending Alibaba IPO as well as what’s already on the balance sheet, rather than see CEO Marissa Mayer and her management team spend it on value-destroying acquisitions.
Mayer has been CEO at Yahoo for two years now. She was absolutely dealt a tough hand, which I think any other CEO, whether Ross Levinsohn or anyone else, would have been challenged to turn around. In fact, I spoke out in her defense early on after her hiring, asking several critics to give her more time to work at her turnaround. Two years after her hiring, however, I think it’s fair to point out that she has made a number of costly and largely self-inflicted errors since taking over.
These include:
She hired Henrique De Castro as her top lieutenant for big money and no results:
- She essentially asked Ross Levinsohn and former head of sales Michael Barrett to leave Yahoo when she took over, in favor of bringing in her own people around her.
- Her top choice was Henrique De Castro – formerly of Google. She made him COO and head of sales (an area all agreed she had no experience in prior to joining Yahoo). He was a hire where I questioned her judgment early on.
- She fired him 15 months later for $58 million in severance (at the time of firing).
- The sales organization’s results have only gotten worse since De Castro was replaced at the start of this year.
- Mayer’s sales blind spot has been a significant deterrent to Yahoo effectively turning around its flagging core business.
She has increased headcount since she came aboard two years ago, not decreased it, which it still desperately requires:
- According to the 2012 10-K, which came out just before Marissa was hired as CEO, Yahoo had 14,000 employees at the end of 2011.
- Four months later, Yahoo’s then-CEO Scott Thompson announced layoffs of 2000 people, taking headcount down to 12,000
- Yahoo’s headcount bottomed out in 2012 at 11,700.
- As of the end of Q2 2014, Yahoo had 12,200 employees according to the most recent earnings call.
- This is a company that was bloated with an excess cost structure before Mayer arrived and it’s only larger today – not smaller.
- Given the shrinkage in the company’s EBITDA over this time, it’s even more puzzling as to why management believes the operating business should be rewarded with more resources and not fewer.
- In the first half of this year, Yahoo had $373 million in EBITDA. Over that same period, InterActiveCorp had $240 million or about 64%. Yet, InterActiveCorp had 4,000 employees and Yahoo has nearly 13,000 – or about 30% of Yahoo’s. Why? Is that an example of what Yahoo CFO refers to when he states repeatedly that Yahoo is a “good steward of shareholder capital”?
None of the $2 billion in acquisitions Mayer has spent in M&A since arriving at Yahoo are reflected in the valuation of Yahoo’s deteriorating core business:
- Can you name any other acquisition Yahoo has made besides Tumblr? If not, what does that say about them?
- If these small acquisitions were mostly talent-driven as characterized by management, why was it necessary to spend, say, $30 million to hire 3 people from a dying company? Was this really the best use of shareholder capital? Yahoo should not responsible for bailing out VCs from their failed investments. This isn’t TARP. Shareholders want to see management spend cash and stock to buy outside companies to see it reflected in increased revenue, EBTIDA and/or the stock price. After subtracting out the increased value of the Alibaba and Yahoo Japan stakes over these last two year, Yahoo shareholders have not seen an increase on any of those metrics. Two years is a sufficient grace period to be able to now pass judgment on the success (or lack thereof) of the deals done to date.
- Now Mayer is preparing to spend at least $2.75 billion on M&A thanks to the Alibaba share sale (assuming it raises $5.5 billion net of taxes and that they spend half of that on buybacks). Why should shareholders expect her decisions to be any better than the last $2 billion spent?
- Investors, as of last week, valued the core business – the only part Yahoo management is responsible for – at negative $4 billion.
- Some have suggested that Yahoo should spend $6 billion or more on buying a company like Yelp. I believe the reason that investors have such a discounted value placed on the core business is that they are assuming that Yahoo will make a poor decision with their newfound Alibaba capital and waste it.
- I believe shareholders should get this money, rather than failed entrepreneurs.
The increase in value of Yahoo’s mobile users would have happened regardless of Mayer’s leadership, given the secular adoption of mobile devices:
- I find it disingenuous when Yahoo management touts the growth of its mobile users, which they say is now up to 450 million.
- You would be hard-pressed to find a CEO who couldn’t have taken Yahoo’s top job in mid-2012 when they had 800 million monthly desktop users and not converted about half of them to mobile users two years later. This is the mobile world we now live in. If you are a consumer Internet service and your mobile users aren’t increasing today, something is terribly wrong with your business.
- Touting Yahoo reaching 450 million mobile users today would be like Reed Hastings boasting today that Netflix had grown its streaming customers to half of the DVD customers they had in 2005. Yahoo shareholders should and do expect more.
- Mayer refuses to disclose any breakout of mobile revenues because they are likely minimal.
Excessive stock compensation in light of declining EBITDA:
- Wall Street’s estimates for Yahoo’s core business revenues and EBITDA have declined meaningfully in the last year according to Yahoo Finance. Yahoo’s 2014 EPS estimates are down 6.5% compared to last year. The 2015 EPS estimates are down 7% from a year ago. Revenue estimates for the current quarter are down 3.7% from last year.
- By comparison, Facebook’s current quarter sales revenue estimates are up 54% from a year ago. Its current year EPS estimates are up 84% from a year ago.
- And this is before the impact of Yahoo’s stock compensation.
- Yahoo’s stock-based compensation in only the first half of 2014, for example, is up to $212 million according to Bloomberg. In all of 2013, their stock-based compensation was $278 million. It was up from $220 million in 2012 and $204 million in 2011 (pre-Mayer).
- Yahoo’s EBITDA post-stock compensation is actually down more than 70% compared to before she arrived (in comparing Q2 2014 to Q2 2012) despite the $2 billion spent on M&A.
- The steady share buybacks which management has followed (and pledged to continue to follow) has a benefit to them of masking the dilution from the additional stock-based compensation granted.
The bottom line here is that Yahoo investors are – and should be – worried about what Mayer will do with the Alibaba cash when it arrives following the September IPO.
What would the reaction of shareholders be if Alibaba was to make an offer to buyout Yahoo and sell the core business to a private equity firm like Silver Lake? Or if SoftBank was to buyout Yahoo and make Nikesh Arora the effective CEO of the company (a person once rumored to be hired as the next Yahoo CEO)?
Because of the tax savings to Alibaba and SoftBank reacquiring their old stakes as I described in my article last week, it’s very easy to see how Yahoo’s shares could go from their current levels of $35/share to $56/share in such a scenario.
However, in either case of Alibaba or SoftBank buying Yahoo, I think it would be highly likely that Marissa Mayer would be replaced as CEO. Because of this, I would expect that Mayer would strongly resist such a buyout scenario by either of these two parties.
Therefore, I think it’s very important that Yahoo shareholders speak out now in support of a tax-efficient transaction with either Alibaba or SoftBank versus giving Yahoo management carte blanche to spend the incoming Alibaba cash on non-value enhancing M&A. Most of Yahoo’s Wall Street sell-side analysts are part of the upcoming Alibaba IPO, and so are hamstrung from speaking out in favor of Yahoo selling to either Alibaba or SoftBank until the IPO occurs.
Carlos Kirjner of Bernstein asked an important question on the most recent Yahoo earnings call:
[D]o you think Yahoo’s business and performance are in good enough shape to assure that the material acquisition, for example buy a company with several thousand employees, would have a good chance of creating value; in other words would it make sense for a business that’s not performing well, when undergoing a transformation to make a large acquisition that could increase executional complexity?
M&A for the sake of M&A is not a recipe that has worked out for Yahoo shareholders in the past.
The only reason for the increase in value of Yahoo shares in the past two years is because Alibaba’s value has gone up from $35 billion to (by some estimates) $200 billion and Yahoo Japan’s value has doubled since the start of 2013 to $26 billion today. Yahoo’s core business has only dragged down the value of Yahoo shares from where it would otherwise be trading.
While Dan Loeb’s Third Point signed a standstill agreement with Yahoo management last year which prevents him from becoming an activist in Yahoo until 2018, this is a situation which is crying out for another activist to take the lead and help unlock at least $20/share – or $20 billion – in value embedded in Yahoo.
