Why Yahoo! Shareholders Shouldn't Get Too Excited... Yet

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After Yahoo! (Nasdaq: YHOO  ) and China's leading online marketplace, Alibaba, finalized Yahoo!'s sale of nearly half its ownership stake, trading volume for Yahoo! stock tripled. Unfortunately, all the trading excitement didn't do much for shareholders. When the dust cleared, the 1.4% increase in Yahoo!'s stock price seems a bit underwhelming considering the news that sparked all that activity.

You'd think Yahoo!'s pledge to return $3 billion of the sale proceeds to shareholders, of the $4.3 billion net it received after taxes, would have elicited more than what amounts to a day of busy-work for traders. Did investors even consider all the things Yahoo can do with the remaining $1.3 billion? Why'd the trading flurry have such piddling results?

A little here, a little there
After years of consistently losing market share and advertising revenue to rivals including Google (Nasdaq: GOOG  ) , AOL (NYSE: AOL  ) , and Facebook (Nasdaq: FB  ) , padding Yahoo!'s ready cash supply is a wise decision. Adding another $1.3 billion to last quarter's $1.9 billion on the balance sheet gives Yahoo! some intriguing options. According to CEO Marissa Mayer, the sale "retain[s] a meaningful amount of capital within the company to reinvest in future growth."

The "future growth" Mayer alludes to could manifest itself in any number of ways. If the rumors are true, there were serious discussions between Mayer and current Yahoo! management regarding what to do with the Alibaba sale proceeds prior to her arrival. Initially, so they say, Yahoo! management wanted to give all the Alibaba sales proceeds back to shareholders.

But word on the street is the former Google exec would like to make a quick, substantial splash in her new role as Yahoo! CEO. How? By quickly diversifying Yahoo!'s offerings -- the lack of which has been a longtime concern of shareholders -- through acquiring an up-and-coming Internet growth company. Names like the rapidly growing online scrapbooking site Pinterest have been mentioned as possible targets.

As for the return to shareholders of that $3 billion, the speculation is it will come in the form of more share buybacks. Share buybacks are iffy propositions that elicit strong feelings, both pro and con. Though reducing a stock's float should increase the value of outstanding shares, generating long-term shareholder returns via buybacks is debatable.

To make the buyback matters worse, with Yahoo! trading near its 52-week high, questions regarding the wisdom of buying back $3 billion in stock at these levels need to be asked. Yahoo!'s traded within a relatively narrow trading range the past year, bouncing between $13.11 and $16.79 a share. Still, wouldn't an even one-time dividend for each of the 1.18 billion shares outstanding intrigue shareholders? Or, better yet, some combination of the two strategies?

Moving forward
Whether Yahoo! bear or bull, closing the Alibaba deal and what that means for Yahoo!'s balance sheet and shareholders is a positive step. And let's not forget: Yahoo! still owns 23% of Alibaba, an ownership stake currently valued at $8.9 billion. Should Alibaba's intended IPO go well, that $8.9 billion could increase.

Given its five CEOs the past two years, and the continual challenges that Google, AOL and Facebook (among others) present, Yahoo! has serious hurdles to overcome. Competing against the sheer volume of users and site visitors Google and Facebook command puts pressure on advertising revenues. For Google, its concentrated efforts to diversify revenue lines have been an unqualified success. AOL 's emphasis on content, with plans to move beyond being a portal to become a user's final destination, will continue to test Yahoo!.

The key questions facing Yahoo! aren't dramatically different than they were six months, a year, or even two years ago. Will the new CEO provide much-needed stability at the top? Can Yahoo! (finally) diversify revenue streams via acquisition or other means? How will Yahoo! capitalize on Alibaba, its most valuable asset?

It's this last question that will determine if that small light Yahoo shareholders see at the end of the tunnel is the sun -- or another train. If you're a long-term investor, in search of a speculative, aggressive growth opportunity, bet on daylight.

Like Yahoo!, one of the many challenges Facebook must overcome is either developing or acquiring additional revenue sources. To find out more about this and other challenges facing the social networking giant, don't miss the Fool's premium report detailing the risks and possible rewards Facebook represents. Click here to get started today.

Fool contributor Tim Brugger currently holds no securities positions in companies mentioned in this article. The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of Google and Facebook. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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