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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.

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