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One gem for Yahoo investors in Alibaba prospectus

When the Alibaba prospectus finally landed Tuesday night, Yahoo investors saw a lot they already knew. But there was a small detail that could soon send Yahoo shares higher.

Yahoo's valuation has long been supported by its 24 percent stake in the e-commerce giant, which is expected to begin trading in the U.S. later this summer. Through Yahoo's own disclosure, investors learned that Alibaba was generating revenue growth above 60 percent with a hefty $4 billion of operating profit in 2013.

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One figure that hadn't been disclosed: free cash flow. On page 15 of Alibaba's prospectus, the company discloses free cash flow over recent periods. Using those, it's possible to calculate 2013 full-year free cash flow of about $5.2 billionlarger than some investors expected. Free cash flow is a measurement of profitability that is often preferred by investors because it reflects how much cash the company has created that could be used for dividends, buybacks, or investments.

Yahoo
Jacob Kepler | Bloomberg | Getty Images

To put that free cash flow figure into perspective, analysts expect Amazon to generate $3.2 billion in free cash flow this year with sales growth of 22 percent. eBay, meanwhile, is expected to have $3.1 billion in free cash flow on 14 percent revenue growth, according to consensus estimates.

Neither of those companies makes an ideal comparison with Alibaba. The Chinese company's main business looks a lot like eBay, but is more similar in scale and domination to Amazon. eBay has a market capitalization of $65 billion while Amazon is worth $137 billion.

So it wouldn't be a stretch for Alibaba's IPO to price at 30 times last year's free cash flow, or $156 billion. Indeed, some estimates have already put the company's valuation closer to $200 billion.

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What does that mean for Yahoo? On a diluted basis, Yahoo owns 22.6 percent of Alibaba's outstanding shares, according to the Alibaba prospectus. If all of those shares were sold at valuation of $156 billion, they would be worth $35.2 billion.


Even that conservative figure should give Yahoo shares plenty of support. Given that Yahoo has about 1 billion shares outstanding, the Alibaba stake would be worth $35 a share, compared with Yahoo's closing price of $36.49 on Tuesday. That also attributes no value to Yahoo's core business.

The Alibaba stake could certainly be worth more. Yahoo has only agreed to sell 208 million shares, or about 9 percent of Alibaba's diluted shares outstanding, in the IPO. If Alibaba trades higher, Yahoo could find a way to cash in the rest at a higher price.

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Of course, hurdles remain. Given Yahoo invested in Alibaba at a lower price, it may need to pay taxes on any gains. It's unclear whether there are any tax-free solutions such as a spinoff to Yahoo shareholders that could solve the problem. And the Chinese economy always carries the risk of a slowdown.

The wait for Alibaba has been longer than many expected. But Yahoo investors should be happy to finally see some of the fine print.

(Disclosure: CNBC has a content-sharing partnership with Yahoo's finance site.)

By CNBC's John Jannarone