Yahoo Takes On The Tax Man – Will Move Forward With Aabaco Spin Without Private Letter Ruling

Yahoo’s (YHOO) planned Alibaba (BABA) stake spinoff was in serious limbo following notification from the IRS that it was declining to issue a private letter ruling blessing the planned transaction. The tricky part was that the government agency also didn’t say that it was objecting to the plan. Here is a good, easy to understand guide to the situation. Limbo is rarely a place welcomed by investors and the news sent Yahoo’s shares sinking as most of the value of this move is in the tax savings. The big question became whether or not Yahoo was going to move forward despite this hiccup and just a few weeks later we have an answer.

According to a recent 8-K filed by the company, the board of directors authorized the company to continue pursuing a spinoff despite this challenge. This can also be seen in the latest amendment to its registration statement, where Yahoo said that it would still be moving ahead with the spinoff, implying that it is confident in the transaction’s tax free nature. The company will obtain a tax opinion from a leading law firm, Skadden Arps, to help support its position in the event it is challenged by the IRS. A tax opinion does not guarantee the company will not be challenged by the IRS or eventually lose in court though. There are numerous sections and paragraphs in the amended filing dedicated specifically to this issue and it’s worth a read.

Yahoo plans to complete the spinoff sometime during the fourth quarter and I bet they are doing everything possible to get this done as soon as possible. Part of the gambit appears to finish this prior to any actual change in law or official guidance in the hopes that any rulings would not apply retroactively. The IRS has become seemingly much more hostile to these types of transactions and one reason is likely the growing brazenness in the marketplace. These are real dollars being kept from the treasury and slapping a $50m EBITDA business as the ‘active’ component in this deal takes a bit of chutzpah. That doesn’t mean it’s a problem or not allowed though.

Of course, as the WSJ notes, if there is an issue, any future tax bill or liability would likely come years down the line after a prolonged challenge and review period. Even if things go wrong, maybe management thinks that by kicking the can down the road they can buy themselves enough time to turn around the remaining business so no one will care. SunTrust analyst Bob Peck thinks the current share price is pricing in the most pessimistic scenario and gives almost no value to the core business. Barron’s highlighted a piece by MKM analyst Rob Sanderson who agrees with that statement:

The current sum-of-parts analysis not only assumes a fully taxed transaction for the BABA spin, it also assumes no value for the core business. • With a fully taxed BABA spin, fully taxed valuation of Yahoo! Japan and the company’s balance sheet, the total sum-of-parts value is over $27 per share, basically in-line with yesterday’s closing price. At the current value of the BABA stake ($22Bn) less YHOO’s cost basis ($2.7Bn), the potential tax liability is $7.7Bn assuming a 40% tax rate. This is over $8 per share. We think YHOO’s core business should support a valuation of 4x EBITDA, which implies $4 per share on our current estimates (relatively in-line with consensus).

Given its struggles, not everyone thinks that giving Yahoo no value is necessarily the wrong approach.

Whichever way the IRS proceeds will likely have a lasting effect on spinoff transactions for years to come so this will be an important one to watch. For Yahoo shareholders though, what really matters is that Alibaba (BABA) shares continue to struggle, which has the unpleasant effect of bringing down the overall value of their holdings and the benefits of this transaction. As we previously noted, the company would have been better off selling its stake and paying the taxes than it is today due to the decline in BABA’s price. If Alibaba’s outlook doesn’t reverse course, then Aabaco shareholders could ultimately be stuck with a sinking ship dogged by the nagging clouds of tax risk.

Disclosure: Author holds no position in any stock mentioned.


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