Alibaba's Value to Yahoo Explains Soaring YHOO Stock Price over Last Two Years By Jim Bach

Yahoo Inc. (Nasdaq: YHOO) stock has been up over the last two years ahead of the Alibaba IPO, given its value as a backdoor play on the Chinese e-commerce company's largest IPO in history. So what is Alibaba's value to Yahoo? The post Alibaba's Value to Yahoo Explains Soaring YHOO Stock Price over Last Two Years appeared first on Money Morning - Only the News You Can Profit From .

Yahoo Inc. (Nasdaq: YHOO) stock has been rising over the last two years ahead of the Alibaba IPO, given its relationship with the massive Chinese e-commerce company.

In fact, Alibaba's value to Yahoo is so strong it's been the main contributor to Yahoo's earnings...

To understand Alibaba's value to Yahoo better, it's best to look at the popular Sunnyvale, Calif.-based multinational Internet company as two separate businesses.

The first is what YHOO is at its surface, or it's "core business." That is, a tenured tech company offering a wide array of online services, including a search portal, e-mail, web hosting, social media, and advertising, just to name a few.

The other can be explained as a lucrative international investment house that puts a heavy emphasis on Asian markets.

Here's how those two vastly different businesses have been doing, and where Alibaba Group Holding Ltd. (NYSE: BABA) factors in...

Yahoo's Value Without Alibaba

YHOO's core business operations have been struggling for years. When the effects of the recession started to sink in around 2009, YHOO's underlying troubles began to surface.

Unable to compete with Google Inc.'s (Nasdaq: GOOG, GOOGL) seeming online search engine hegemony, and trying to poach advertising dollars from growing competitors like Facebook Inc. (Nasdaq: FB), YHOO's biggest challenge was its inability to compete for market share in a difficult sector.

After growing revenue 3.4% in 2008, YHOO posted three consecutive years of revenue decline. In 2011, sales saw their biggest drop to the tune of 21.2% in 2011.

The troubles in 2011 led to the firing of then-Chief Executive Officer Carol Bartz, who failed to remedy the troubled internet firm's dwindling revenue numbers, and corporate governance continued to hamstring an often referred to YHOO "turnaround" that seemed perpetually out of reach. Just four months after hiring new CEO Scott Thompson, he was fired for fudging his resume.

YHOO then called on Marissa Mayer to lead the turnaround.

The results were less than stellar, and continued to highlight the inherent weaknesses in YHOO's core business operations.

Every quarter since Mayer has stepped in has shown a drop in revenue from the year before. Yearly results in 2013, Mayer's first full year at the helm, showed a decline in sales of 6.1%.

And in the most recent quarter, revenue fell 4.5%.

If Mayer's going to turn around the company, there is still a lot of work to be doing in the core business.

You wouldn't know this, though, looking at the YHOO stock price.

This is why YHOO's dual role as tech giant and makeshift investment house is so important, as the latter part of the business is subsidizing the floundering former part.

What Does Alibaba Mean for Yahoo?

To understand the true value of Alibaba as a Yahoo interest, just look at Mayer's first move as CEO, and what it gave to shareholders.

When Mayer stepped in, YHOO had a 40% stake in growing Chinese e-commerce giant Alibaba, representing about 1.05 billion shares that were first purchased for $1 billion in 2005. It was a way for YHOO and Alibaba to challenge eBay Inc.'s (Nasdaq: EBAY) dominance in the online auction marketplace in China.

Earnings per share had dropped in 2011 to $0.82, from $0.91 in 2010.

At this point, YHOO was looking to monetize part of its holdings in the growing Chinese e-commerce giant and deliver to shareholders. It did so in a big way.

YHOO reduced its stake in Alibaba to about 24% with the sale of 523 million shares, and earnings soared 276.2%, from $1.05 billion to $3.95 billion. This sale netted YHOO $4.6 billion in pre-tax earnings, and increased the EPS to $3.31, compared to the $0.91 the year before.

The move helped YHOO shares grow 170% under Mayer despite no discernible turnaround in revenue figures.

As per an agreement between the two companies that came with this sale - and was amended thereafter a couple times - YHOO further reduced its stake to 16.3% with the sale of another 121.7 million shares on the Chinese company's IPO.

But blockbuster sale aside, YHOO has been supporting the troubles of its core business with the gains in its international investments for some time now.

Looking at YHOO's earnings over the last few quarters, its income from operations have fallen every year since the third quarter of 2013. This past quarter, income from operations has fallen about 72% year-over-year.

But its earnings from investments, which include Alibaba, have grown year over year every quarter by double digit percentages. This last quarter represented the smallest gain from equity interests since the third quarter of 2013, and was still a 14% gain. And it also followed two years of gains above 30%.

Income from operations in the most recent filing was at $137 million, while equity interests provided $224.7 million.

These equity interests include the 24% stake in Alibaba, and a 36% stake in Yahoo! Japan. Because YHOO doesn't detail what portion of the equity interest income comes from which investment (and has confirmed that it won't disclose this in its reporting), there's no way to tell how much of it is coming from Alibaba.

However, it makes sense that Alibaba's growth is driving this up significantly, as YHOO Chief Financial Officer Ken Goldman said in an earnings call in July that the 14% growth in equity income - down from 24.8% a year before - was fueled by "growth in Alibaba Group" offset "by a decline in Yahoo! Japan."

In an analyst note by Morningstar analyst Rick Summer, YHOO was recently given a fair value estimate of $39 in July (it has since been revised up to $42 ahead of the Alibaba IPO). Summer said Alibaba represents $23 of that value. Summer said YHOO's core business represents $11, with the remaining valuation a combination of Yahoo! Japan and its cash holdings.

"We believe that today's stock price is predicated on a robust valuation and successful exit of Yahoo's investment in Alibaba Group," Summer wrote.

Money Morning Executive Editor Bill Patalon: The Alibaba IPO is history in the making for savvy investors. Here is why the company is poised to take off, and how China's booming e-commerce sector is going to help keep the profits rolling in...

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The post Alibaba's Value to Yahoo Explains Soaring YHOO Stock Price over Last Two Years appeared first on Money Morning - Only the News You Can Profit From.

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