Hedge fund Ivory Investments, which owns 1.5% of Yahoo (YHOO), told the company’s board a search deal with Microsoft (MSFT) would double Yahoo’s share price all by itself.
Ivory argued Microsoft would pay more than $15 billion up front, and give Yahoo 80% of future revenues, boosting earnings by more than $500 million a year.
Here are Ivory’s assumptions:
- Yahoo would lose annual search revenues of roughly $1.7 billion. However, offsetting this shortfall would be over $1.6 billion of annual TAC payments received from Microsoft. This payment stream assumes a TAC rate of 80% and that the combined search platform can garner 20% higher monetization.
- We estimate that Yahoo could eliminate over $1 billion in annual costs related to search.
- As for the benefits to Microsoft, this transaction could allow them to increase net search revenues by approximately $1 billion per annum, comprised of (i) $100 million of revenue synergies from its estimated $500 million of search revenue, (ii) over $400 million from the retained 20% share of the new Yahoo search arrangement assuming higher monetization rates, and (iii) $540 million of revenues from Yahoo’s affiliates (120% of the $450 million that Yahoo currently earns).
- To earn these revenues, we assume Microsoft would have to additionally spend only 20% of Yahoo’s current level of search expenses, or an incremental $200 million (due to current duplicative spending).
- The net effect is a pre-tax profit increase of over $800 million per year for Microsoft. Microsoft has tremendous cash resources (over $20 billion of cash as of the latest quarter) and the ability to borrow at exceptionally low rates (it just issued commercial paper at 1.42% last quarter).
- Assuming Microsoft earns 3% on current cash and pays a 30% tax rate, Microsoft could pay Yahoo over $15 billion upfront in this transaction and the deal would still be accretive to Microsoft’s earnings per share. Over time, with this new critical mass, we expect Microsoft would be able to gain meaningful share from Google (as many advertisers could eagerly re-allocate their ad spending to a strong number two player), making this deal even more attractive in future years.
- What is the bottom line of this proposed deal for Yahoo’s shareholders? On an after-tax basis, the $15 billion payment from Microsoft would be $9 billion for Yahoo shareholders, leaving Yahoo with $21.2 billion of cash and investments (up from $12.2 billion today) and annual EBITDA of $2.4 billion (up from the midpoint of current guidance of $1.9 billion). Applying a 5x EBITDA multiple on the “new Yahoo” would result in a value of $24 per share.
- If Yahoo were to go a step further and deploy the $9 billion in new cash to publicly tender for its own shares at a $16 offer price, [Yahoo] could reduce its share count by 40% which would leave the remaining shareholders with a stock value approaching $30 per share (amazingly close to the original bona fide bid from Microsoft).
Ivory’s press release and a copy of their letter to the board:
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