Will Yahoo get hammered by the IRS, or is its core business worthless? Based on a simple analysis of the company, at least one of these unattractive assumptions is currently held by investors.
Yahoo was recently hit with some unwelcome news, as the IRS told the troubled Internet company that it would not make an advance ruling on whether a spinoff of its Alibaba shares would subject it to a hefty tax bill. That increases the uncertainty around Yahoo's $23 billion worth of Alibaba stock, and has caused analysts to lose some or all of their faith in a tax-free disposal of the shares.
For instance, in a Wednesday note, Gene Munster of Piper Jaffray saw fit to "adjust" his price target on Yahoo from $54 to $32, "reflecting our assumption for 38 percent tax rates on both the BABA and Yahoo Japan stakes (previously assumed 0 percent)."
Judging by the price of Yahoo shares, however, investors have long believed that it is likely to be taxed on its Alibaba stake.
A company like Yahoo is generally evaluated based on a "sum of the parts" valuation, whereby the value of disparate businesses or holdings are added together to arrive at a value for the shares.
Some parts are valued straightforwardly. For example, Yahoo holds nearly $6 billion in cash and marketable securities; dividing by Yahoo's 941 million shares, one finds a value of about $6 per share. And using the assumption of Munster and other analysts that the Yahoo Japan stake will be taxed at 38 percent, that holding is worth a bit less than $5 billion, for a value of $5 per share.
Valuing Yahoo's Alibaba stake is where this exercise gets difficult. Assuming that Yahoo is able to dispose of the shares in a tax-free manner and realize their full market value, the 15 percent stake in Alibaba is indeed worth $23 billion. This would be good for a value of more than $24 a share.
Adding up these figures, one arrives at a share value of $35—well above where Yahoo is trading. And this is even before considering the value of Yahoo's core business, which is expected to generate about a billion dollars in earnings before interest, taxes, depreciation and amortization (or EBITDA) in the coming year. Actually, this would imply a value of negative $3.5 billion for Yahoo's core business.