Yahoo could lose a deal that pays it about $100 million a year in pure profit if any of these things happen

Yahoo has a royalty deal with Yahoo Japan that pays 3% of the Japanese site’s gross profit every year — forever.

The royalty deal, struck in 1996 when Yahoo Japan launched in partnership with Softbank, basically gives the Japanese site the rights to use Yahoo’s brand.

In other words, Yahoo gets free cash that amounted to over $90 million last year, for doing nothing, since it isn’t involved with Yahoo Japan’s day-to-day operations.

Not many people were aware that this deal runs in perpetuity until last week, when SunTrust analyst Robert Peck discovered it. Peck wrote in a note that the royalty deal itself could be worth over $1 billion, and potentially play a huge role in boosting the value of Yahoo’s core business, which owns the rights to the royalties.

Because of its massive hidden value, a couple analysts asked during Tuesday’s earnings call if the Yahoo Japan royalties had any expiration date or an “out clause” that could potentially terminate the deal. Yahoo CFO Ken Goldman reaffirmed that the deal runs forever, stressing there’s no expiration date.

But a closer look at the actual terms of the deal shows the royalties could come to an end under certain conditions. Although the chances of it actually happening are low at this point, Yahoo stands to lose a free cash deal that netted nearly $100 million last year if one of the following four things happen, according to Yahoo Japan’s annual report:

  • Mutual decision by the companies to terminate the agreement;
  • Cancellation of the agreement following bankruptcy or loan default by one of the companies;
  • Purchase of one-third or more of the Company’s outstanding shares by a competitor of Yahoo! Inc.;
  • Merger or acquisition rendering Yahoo! Inc. and SOFTBANK CORP. incapable of maintaining over 50% of shareholder voting rights of the Company (may be waived by agreement of Yahoo! Inc.).

The first two clauses are unlikely to happen. But it’s plausible the third and fourth conditions could be realised if Yahoo decides to sell its 35% stake in Yahoo Japan to another company.

Softbank, the majority owner of Yahoo Japan, reportedly wants out of this deal, and according to SunTrust’s Peck, it’s interested in buying back Yahoo’s 35% ownership stake as well.

It’s unclear if Yahoo is planning to sell its stake in Yahoo Japan, but Peck says the royalty deal itself could be sold separately, if Yahoo wanted to. In that case, Yahoo Japan, which has had its
18th straight year of record-high revenue and profit, will have to pay a growing amount of royalties to the buyer.

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