Last Friday, Alibaba (NASDAQ: BABA) held a spectacular market debut in what was undoubtedly the single-most trumpeted stock market story of the year.
The Chinese e-commerce company was widely predicted to become the biggest IPO in the history of trading, and it fell just $2.5 billion short of that record on its first day.
As of yesterday, though, the predictions became true — underwriters of the Alibaba IPO released an additional 48 million shares in over-allotment options (a.k.a. the “Green Shoe”), bringing the total amount raised to $25 billion dollars.
Shares topped at $99.04 on Friday and settled in the low $90s by close. If you plan on following this story in the mainstream media throughout the week, I can save you the hassle right now.
Wall Street Joe will tell you Alibaba is overvalued because the company is trading at 300 times its current earnings, there is little room left for growth, and the Chinese market has historically burned American investors.
Wall Street Jane will tell you Alibaba is undervalued because the company controls 80% of Chinese e-commerce market, has a wide economic moat in Asia, and is actually a more diversified company than the market realizes right now.
Valid arguments will be presented on both sides, but when you mash it all together, it’ll amount to little more than a bunch of noise.
The reality is none of these people have the slightest clue where Alibaba is going to trade a few years down the road, and most of them don’t even care. They’re simply partaking in rule #1 of “good” journalism and focusing on what’s hot and trending.
Hidden behind all these Alibaba talking points, however, is a far more interesting story for investors looking to make a buck. This is the story of Yahoo! Inc. (NASDAQ: YHOO) and its now highly undervalued share price.
Market Blinders
Leading up to the Alibaba IPO, many investors piled into Yahoo knowing it held a significant stake in Alibaba. The general sentiment was that if Alibaba had a strong IPO, the value of Yahoo would skyrocket alongside it.
Curiously enough, though, this isn’t what happened at all. Despite Alibaba being the largest IPO in market history and Yahoo receiving an enormous amount of cash in proceeds, the company’s stock has actually fallen ~9% since Friday.
Why? Well, for a few reasons…
First, many saw Yahoo as a backdoor play to Alibaba when the company was still private. When Alibaba hit the market, these investors sold their backdoor plays in Yahoo to purchase Alibaba instead.
The events are similar to what happened with Firsthand Technology Value Trust (NASDAQ: SVVC) — a business development company — when it held shares of the once privately held Twitter (NYSE: TWTR) and Facebook (NASDAQ: FB). Impatient investors drove up the share prices leading up to these IPOs and then dumped what they were holding when the companies became public.
Secondly, many investors have been using Yahoo as a way to hedge their bullish outlooks on BABA. Investors either sold their shares in Yahoo to limit their exposure or shorted the stock as a security measure. Remember, the market believed Yahoo and Alibaba would move in tandem, so if Alibaba tanked, a short against Yahoo was expected to limit those losses.
The problem is so many people had this idea that the selling pressure on Yahoo became too great. There has simply been so much focus on Alibaba that the market has failed to stop and consider the fair value of Yahoo.
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A Free Company
Due to this unusual combination of events, Yahoo is currently selling at a bargain price. In fact, the company is theoretically free right now. You could even say the market is willing to pay you to buy it.
Here’s why (Warning: incoming math):
Yahoo sold approximately 122 million shares of Alibaba in the IPO at a price of $68 a share. That’s about $8.3 billion in proceeds. Yahoo said it would take a full tax burden on these shares, which conservatively leaves the company $5.4 billion if we assume a 35% tax rate.
Additionally, Yahoo still holds approximately 402 million shares of Alibaba. At $90 a share, that’s about $36.2 billion.
Yahoo then holds a 35% stake in Yahoo! Japan (TYO: 4689 / OTC: YAHOF), which has a market cap of $22.5 billion. This gives Yahoo another $7.9 billion.
Finally, we can take Yahoo’s net cash of $1.6 billion and add it all up. What do we get? About $51.1 billion for a company with a current market cap of $38.5 billion.
Whether or not Yahoo can avoid the tax burden on its remaining equity in Yahoo! Japan and Alibaba will be important, but even if we assume a 35% tax rate, all our figures still add up to $36.1 billion.
In either case, the market is currently valuing Yahoo’s core business at less than or next to nothing. This is for a company that’s posted an average annual profit of $652 million over the past three years.
The valuation is compelling either way.
Until next time,
Jason Stutman
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