3 Reasons Why AOL-Yahoo! Won't Happen

The forks keep clanging the Champagne glasses, louder and louder.

Go ahead, AOL (NYSE: AOL  ) . Kiss Yahoo! (Nasdaq: YHOO  ) . You know it wants it.

Unfortunately for all of the buzz that's been building over the past few days, while a marriage between the two dot-com laggards makes sense on paper, it's going to be hard to pull off the deal in reality.

The Wall Street Journal spells out the scenario this morning, where private equity firms team up with AOL to buy the larger Yahoo!. This sets the stage for Tim Armstrong -- AOL CEO and former Google (Nasdaq: GOOG  ) executive -- to run the combined company.

The news has been enough to send Yahoo! shares speculatively higher this morning, but check your enthusiasm at the door, folks. There are several hurdles along the way. Let me go over the doozies.

1. Cheap is relative
At today's prices, Yahoo!'s most valuable assets aren't homegrown. It is the meandering dot-com's stakes in Yahoo! Japan and China's Alibaba that have kept the shares in the double-digits.

ThinkEquity analyst Aaron Kessler recently concluded that liquidating the positions would result in roughly $9.50 a share in proceeds after taxes.

Yahoo! also had $3.8 billion in cash and marketable securities at the end of June -- or about $2.70 a share. Let's go ahead and round this all down to $12 a share.

The unlocked value in Yahoo!'s overseas investments and balance sheets is going to be a natural attraction to key-waving firms. Private equity can cash out of its Asian investments (and China, for one, really wants its Alibaba baby back), and a buyout at $16 would really mean a net price of just $4 a share.

Well, we know what buyout buzz does to a stock. If private equity firms have to pay $20 instead of $16 -- even if it's just a few bucks -- it means that the firms would be paying twice as much for Yahoo! after unloading the $12 per share dowry.

If Yahoo! demands a $32 exit price -- or twice what it's worth today -- it would mean that the real cost would be five times greater (or $20 versus $4). In other words, this plan begins to fall apart quickly if Yahoo! shareholders expect a sizable buyout premium.

2. Yahoo! won't kowtow quietly
In a CNBC interview earlier this year, CEO Carol Bartz claims that she would have accepted Microsoft's (Nasdaq: MSFT  ) 2008 buyout offer in the low to mid $30s. Given the "sum of its parts" argument I voiced earlier, no one is going to pay that much for the purple bleeders.

There is potential at Yahoo!. The portal continues to draw a ton of traffic, even if it's a monetizing challenge. However, there is going to be a big gap between what private-equity firms are willing to pay and what Yahoo! will accept.

Buying Yahoo! won't come cheap, especially if the game plan is to have the CEO of the much smaller AOL call the shots. Shareholders may not like it, but forcing Yahoo! to have its pride publicly gutted in playing second fiddle to AOL is going to have to come at a steep price.

It's not likely to happen.

3. There is another way out
Yahoo! has resisted Alibaba's advances to buy its 40% stake in the company behind China's leading B2B and consumer-facing marketplaces. However, if Yahoo! has to explain why it's not going to punch out at $18 or $20 in a hostile privatization coup, it may be forced to sell its Asian investments and pay out a chunky one-time dividend. A naked Yahoo! would be an eye-opener, but it would be beating the firms to the punch.

Thankfully, there's another option. That $3.8 billion in the bank can go a long way in a shopping spree.

Yahoo!'s name has already been attached to buyout rumors of Groupon and Huffington Post that have failed to materialize, but there's plenty of other fat fish in the sea.

It can't afford Facebook. Twitter would be another high-traffic, crummy-monetization situation.

  • The Knot (Nasdaq: KNOT  ) is being served up as buyout bait by at least one major analyst. Traffic growth is suppressed, but the monetization potential is enormous.
  • IAC (Nasdaq: IACI  ) may be willing to give up Ask.com. It would be one way to widen the gap between Yahoo! and AOL.
  • MercadoLibre (Nasdaq: MELI  ) would give Yahoo! a huge presence in Latin America and help establish an e-commerce marketplace presence that Yahoo! sorely lacks.

If Yahoo! wants to turn off potential buyers, fattening itself up with acquisitions is an easy path -- as long as it's buying companies that make sense.

Sorry, AOL. Better luck next time, private equity.

Do you think Yahoo! will be bought out? Share your thoughts in the comment box below.

Google and Microsoft are Motley Fool Inside Value selections. Google, The Knot, and MercadoLibre are Motley Fool Rule Breakers recommendations. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Longtime Fool contributor Rick Munarriz wonders if AOL will ever party like it's 1999. He does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy, and it's got mail.


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  • Report this Comment On October 14, 2010, at 5:38 PM, TigerPack1 wrote:

    Rick, glad to see you let the WSJ and CNBC do your thinking for you... Here is what I posted this morning in a couple of blogs in case you missed it:

    Many of you on CAPS know, I have been adding shares of Yahoo! for over a year now to my various brokerage accounts. It is by far my largest real world position. Here is some of the logic for my interest and ownership:

    Yahoo! (YHOO) is an internet-based business, using content delivery, web advertising and some subscription services on their expansive worldwide computer network to generate revenues and profits for its owners and stakeholders. To a degree, an investment in YHOO is also an investment in several high growth, quite valuable internet businesses globally. Not only do owners control and reap the rewards of Yahoo!’s U.S. and European Media/Content/Search assets, but they own a disproportionately larger stake in Yahoo! Japan and the Chinese-based Alibaba.com in Asia.

    Yahoo! represents an attractive valuation at today’s sub-$15 share price and $20 billion market capitalization. The company has a break-up value at, or above, current pricing based almost entirely on its subsidiary and overseas investments. Yahoo!’s ownership stakes in both of the Asian enterprises are today valued at $15-19 billion by Wall Street and market pricing estimates (pre-tax). [The Yahoo! Japan investment is valued at $8 billion from the June 2010 SEC 10-Q filing and Alibaba at $7-$11 billion by Wall Street, as represented in many mainstream stories printed the last month.] Additionally, the company holds another $6-8 billion in cash assets and investments beyond Asia versus just $2.2 billion in TOTAL liabilities on the latest balance sheet (June 2010). We come up with total assets, based on market pricing and fair value calculations, of $21-$26 billion (pre-tax) versus roughly $2 billion in direct liabilities for Yahoo! owners. The net break-up value of Yahoo!’s” non-core” U.S. business interests is likely in the $17 to $19 billion range, if Yahoo! was liquidated immediately, after taxes on capital gains are paid, and the money returned to shareholders. This should provide investors with a strong “margin of safety” under a variety of adverse stock market and economic scenarios.

    Earnings and revenues are growing during the slow economic growth period in 2010. The small uptick in the economy in 2010 is moving directly to Yahoo!’s bottom line. Cost controls, a focus on increasing the breadth of content and total page views, alongside a small jump in banner ad rates, and new partnerships with the internet’s elite sites (including Ebay, Facebook, Twitter and many others) ARE propelling margins and total profits at Yahoo! to new record heights in 2010. Despite the turmoil in management ranks the last few years, and changing focus, I believe the company is clearly headed in the right direction, despite what you read in the WSJ or hear on CNBC. At this stage, the negative view of Yahoo! by investors and advisors is not based on Yahoo!’s business fortunes long-term, but purely on the underperformance of its stock price over many years.

    The Microsoft-Yahoo alliance/partnership in Search-related subscriptions and advertising (announced last year) is helping to drive a real increase in GAAP earnings in 2010 also, and lower the necessary capital expenditures by Yahoo! to stay competitive with Google, the Search leader in America. I am estimating that by this time next year, Yahoo! will surpass Google’s ultrahigh net profit margin on sales, after-tax. This estimate revolves around the steady decline in Google margins as competition in Search is fierce, and the steady improvement in YHOO’s results in 2010 and projected for 2011.

    Yahoo!’s business model of low cost advertising on the web provides perhaps the “best” inflation and hyperinflation hedge available to large dollar, blue-chip investors. Of all the different companies I review for possible investment, Yahoo!’s super brand name, Media-like assets may provide the best upside to revenues and earnings of all risk-adjusted asset plays during a period of high inflation or hyperinflation. Yahoo! should be able to keep costs per banner ad, clicks and content page draws quite low on existing computer infrastructure, especially as they acquire new content monthly, integrate them with Yahoo!’s workflow, and synergize/computerize the creation of ad revenue. Given higher inflation rates, it will be easy for Yahoo! to pass along advertising rate increases in price to end users, as other newer content providers struggle to turn a profit. I am estimating GAAP, earnings per share growth rates for YHOO will be double the rate of inflation PER YEAR. For example, if we get 10% inflation in 2011, I would expect GAAP earnings will rise at least +20% over 2010, even if the economy is in mild recession. At this stage, another recession will likely put most old-time newspapers out of business, further enhancing Yahoo!’s appeal as one of a select few of national advertisers on the web, with both local and national content for readers. In effect, Yahoo! is becoming THE National LEADER (if not global) in web content, new age Media delivery, and simple, low cost advertising for all businesses!

    Yahoo's $13 low price in the summer of 2010 represented its lowest "relative" valuation vs. market multiples and metrics since it became a public company in the mid-1990s. Over the past 10 years, Yahoo!'s relative multiples versus the market have averaged closer TWICE the metrics of the S&P 500 stocks, as a result of its higher than normal growth, higher than normal profit margin business. At 2 times "tangible" net book value (with assets recorded near cost value, not market value), 20 times trailing earnings per share and more like 16 times, near future "free" cash flow, YHOO stock has NEVER been cheaper. In addition, the Yahoo! Japan and Alibaba stakes are worth a good $4 billion more than one year ago (from SEC filings and Wall Street estimates), when the stock was priced around $15-16 a share, after the Microsoft Search deal was announced to little fanfare.

    The company is intelligently buying back shares at this low valuation, enabling existing shareholders to capture a greater piece of the long-term pie as revenues and earnings rise in the future. They have purchased over $1 billion in stock this year, with their huge cash stash of $3-$4 billion entering 2010, and a good $1.2-$1.4 billion in “free” cash flow generation during the year. They continue to forge new partnerships with existing internet site leaders to increase traffic, and are buying content or display ad firms almost weekly to lay the foundation for revenue growth down the line.

    The great Fidelity investor of the 1970s and 1980s, Peter Lynch always advised investors to simply buy the stocks of the businesses they used, liked as a consumer, and felt had real product value and differentiation. If you use this metric, Yahoo! is a product almost everyone I know uses and appreciates on a daily basis. Other great long-term investors like Carl Ichan and George Soros have built LARGE stakes in Yahoo! stock the past 12-18 months also. They believe in the product, the profit margins, the growth potential of the businesses Yahoo! owns, and the utterly cheap valuation Wall Street currently applies to these assets.

    Through a number of potential catalysts - a takeover, a break-up, spin-offs, asset sales, smart acquisitions, higher inflation, better economic growth, and others, current shareholders should be rewarded handsomely in 2011 by owning Yahoo! shares.

    Microsoft already bid $27 a share for Yahoo! in 2008 and could definitely benefit from owning YHOO’s content infrastructure (eyeballs) and Search assets. Additionally, Microsoft could gain instant clout and access to China through Alibaba. Mr. Gates just went to China on a fact finding tour, and Microsoft just raised an extra $6 billion in a bond offering a few weeks ago. They already have some $36 billion in cash and short-term investments domiciled in various units and nations. I would not be surprised by a $20+ a share bid by Microsoft in the near future, or a large private equity fund.

    Yahoo! is in the process of gaining an additional board seat and de facto management control of Alibaba, the next few months. They are pushing hard into mobile phone chat applications and content/ad delivery, and rumors abound that a major acquisition of content provider AOL is in the offing. Merging the Yahoo! and AOL brands would be a brilliant move at the right price, as it would eat up one of the top competitors in content, bring in bright managerial talent, and allow YHOO to own several new promising technologies that AOL holds. YHOO would stand head and shoulders above everyone for content delivery with such a move, with Microsoft and Google far behind. Another story out this week, places a large private equity group as showing interest in acquiring AOL and Yahoo!, then selling off non-core assets. In the end, if another bidder besides Microsoft appears, a bidding war will likely result as Microsoft will not want to let this cheap, one-of-a-kind asset get away.

    -TigerPack

  • Report this Comment On October 14, 2010, at 8:24 PM, TigerPack1 wrote:

    http://searchengineland.com/microsoft-makes-45-billion-bid-t...

    Corrections from 2008 Microsoft bid linked above. The "official" bid price was $31, half stock and half cash. Microsoft's price fell to reduce the potential price into the upper $20s if I recall correctly. Yahoo! demanded a higher price, Ichan got involved in Yahoo! shares, and Microsoft walked.

    Softie may not be able to walk this time if another smart bidder appears. I am expecting a private equity bid with several partners wanting a piece of Yahoo! to be over $20 a share initially. Microsoft will raise the price at least 10%-15% above that to attract some attention. A second higher bid by the private equity group would make things more interesting. I strongly believe Yahoo! is worth mid-$20s today, and will grow above $50 a share the next 3-5 years if left alone.

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