As Yahoo shareholders, we’d be thrilled if Microsoft’s $31-a-share “massively undervalued” the company–as Yahoo’s board declared through the Wall Street Journal over the weekend–but it doesn’t. And not only because no one else is willing to step up and pay even $31. Because even Yahoo’s expert advisors can’t come up with compelling logic to support the idea.
For example, here are the “massively undervalued” data points fed to the Journal:
- Yahoo has a leading position in display advertising
- $31 does not provide compensation for the risk that regulators will block the deal
- Yahoo’s stock is at a three year low
Remember seeing these arguments in recent analyst reports on Yahoo? Of course you don’t. Because they’re silly. Let’s take them one at a time:
Yahoo’s leading position in display advertising. This is only worth as much as Yahoo can wring out of it in terms of free cash flow. And in recent years, Yahoo’s had trouble wringing out all that much. In 2008, moreover, the company’s free cash flow will drop precipitously, despite the company firing 1000 employees this week. (Note that Yahoo’s board didn’t mention the declining cash flow when making its “massively undervalued” argument).
No compensation for the risk that regulators will block the deal. Yahoo’s stock jumped 50% on the bid. Some would argue that that’s at least some compensation. (This one’s clever, though–because it introduces the idea that Yahoo thinks the deal will be blocked, but it does so through a backdoor–so the board can’t be accused of scaremongering).
Yahoo’s stock is at a three year low. Motorola’s stock is near a $15 year low. This doesn’t make it cheap. Yahoo’s margins have been declining relentlessly in recent quarters despite continued strength in online advertising. Its people have been streaming out the door, its market share has been bleeding away, and its management team has only now, with the threat of the losing the company, developed a real sense of urgency. Yahoo’s stock is low for a reason–and there’s no guarantee that management will ever rectify this situation.
You’ll notice that none of these arguments include actually relevant valuation measures such as profit multiples and comparable-company analyses. These metrics are the only ones that actually mean anything. On these metrics, moreover, Microsoft’s bid looks quite generous.
How generous? Well, here’s what RBC’s Jordan Rohan has to say on the subject (Jordan, by the way, thinks that the stock’s going higher because Microsoft will raise its bid–but not because Yahoo is “massively undervalued.”)
- Yahoo (YHOO) is worth about $24
- 35X 2009 estimated EPS = $26
- 12X 2009 estimated EV/EBITDA = $26
- 4% free cash flow yield = $21
So what does Yahoo’s management need to do to actually persuade anyone that $31 “massively undervalues” the company? Demonstrate why Yahoo’s strategic plan is going to lead to future cash flows that are vastly higher than the ones Wall Street currently expects. The board isn’t trying to do it, so we can probably conclude that it would be very hard to do.
(The board’s invoking the “undervalued” defence is understandable, of course: By not rejecting the offer outright, Yahoo’s board is doing what it is legally obligated to do, which is look out for the best interests of Yahoo shareholders. If it just rejected the offer by saying it didn’t want to sell, it would get sued).
Ultimately, of course, Yahoo is worth what anything is worth–what someone else will pay for it. Maybe Micrsosoft can be convinced (or spooked) into paying more for it. But this won’t mean that $31 was “massively undervalued.”
UPDATE: In its formal rejection of the offer this morning, Yahoo changed its undervaluation adjective from “massively” to “substantially” and, for the first time, it also mentioned “future growth and earnings potential”. Details here would be helpful.
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