The sentiment on the stock is now as if they’ll never make the spin happen, but Yahoo! has multiple paths to upside, he thinks:
Yahoo holds a 15% stake in Alibaba, but intends to spin it off in 2H15 in an effort to realize the value of this material component of its sum of the parts and market cap. At current levels, we estimate Yahoo! is pricing in a 100% probability of fully taxed Alibaba spin-off at ~35% tax rate. Naspers is trading at a 10% discount its sum of the parts, a 17% discount to our fair value assuming a 20% liquidity discount. Our View Yahoo!’s pending 2H15 Alibaba spin faces IRS uncertainty, but our option tree shows multiple other ways Yahoo! can outperform, ranging from 15% upside (a buy and hold strategy for Alibaba with no liquidity discount closing) to 30% (a successful spin). Even assuming a 50% probability of a tax-free Alibaba spin implies 15% upside (assuming no Alibaba share price appreciation).
If the IRS blocks an Alibaba tax-free spin, Yahoo! could just hold it and and still appreicate from here:
The company could choose to continue to hold Alibaba shares (remain long BABA), in which case we believe there is at least 15% upside to current levels based on our bullish view on Alibaba ($112 price target). Note that this assumes that Yahoo!’s core business is valued at 4.5x EBITDA, Yahoo! Japan and Alibaba trade at their respective Morgan Stanley price targets, and that their liquidity discounts both move to 35%.
Or, Yahoo! could “explore other strategic options,” such as “put more active assets in a new SpinCo to meet any new (potential) ATB requirements or explore other strategic alternatives with Alibaba and/or Softbank (given Yahoo!’s 35.5% ownership in Yahoo! Japan and Softbank’s (covered by Tetsuro Tsusaka) 36% ownership in Yahoo! Japan).”
Finally, if Yahoo! takes the full 35% tax hit, there’s only about 5% downside, he figures, in the share price, to $37
He notes “This is the lowest probability outcome, as it would likely be irrational for Yahoo! to sell its stake in Alibaba at a 35% tax rate… particularly if it believes in its long term value.”
Nowak goes on to show that assuming a low 25% probability of a tax-free spin, resulting in a fairly high tax bill, the stock price of Yahoo! currently implies a fairly low valuation for the core business: “If you place, for example, a 25% probability on it selling Alibaba tax free the current core stub businesses are trading at just 2x EV/EBITDA.”
Nowak’s analysis seems spot on to us- the market is assuming the absolute worse as well as continuing to value Yahoo’s core business at nearly nothing. There is ample room for upside at current prices.
Disclosure: The author holds shares in Yahoo