Yahoo! (NASDAQ:YHOO) bears will rightfully explain that the stock's price has increased more than 150% in the last 16 months...without producing any fundamental growth. These investors make a very important observation, one that should deem Yahoo! a bad investment going forward. However, these bears miss one very important point, and that is Alibaba.
The Alibaba impact
Alibaba is China's premier and fastest growing e-commerce company, even larger than Amazon. Unlike Amazon, Alibaba does not create revenue from products sold but rather a combination of advertising and cloud infrastructure offerings.
This is a company that is preparing for one of the largest tech IPOs in history, a company whose expected market capitalization continues to soar by the month. Back in October, IPO rumors pegged a market cap of $100 billion for Alibaba, and this was based on 70% top-line growth and quarterly net income of $669 million; thus making Alibaba a faster growing and more profitable company than Facebook.
Alibaba's market capitalization and revenue growth is important because Yahoo! owns a 24% stake in the company. As mentioned, Alibaba's predicted valuation continues to soar, and RBC's Mark Mahaney now believes the e-commerce company is worth $150 billion; this comes just months after $100 billion IPO rumors surfaced. If correct, Yahoo!'s pre-tax profit for its stake would be in excess of $35 billion.
Cash and investments play an important role
For retail investors, the most watched metrics of a company are often revenue and net income growth, as both are flashy numbers that can easily be compared to a company's valuation. However, a company's cash position and investments are equally important, as they signal financial strength, longevity, and give companies the ability to make large investments.
So, if Yahoo!'s stake in Alibaba is in fact worth $35 billion, then nearly all of Yahoo!'s $41 billion market capitalization is directly tied to this investment. Hence, if we add Yahoo!'s $1.8 billion cash position, then Yahoo!'s fundamentals support a market capitalization of about $4 billion.
If you don't think this is a relevant valuation tool, then just think back to last year when shares of Apple (NASDAQ:AAPL) were falling from a cliff. At the time, Apple's cash position constantly came into consideration, as bulls would note that its stock traded at just seven times forward earnings "minus cash." Apple's stock has since recovered and remains very cheap at 10 times forward earnings minus cash. However, Apple's valuation is nowhere near as cheap as Yahoo! with its Alibaba investment.
Yahoo!'s valuation (minus Alibaba)
Therefore, cash and equivalents come into play regularly when assessing companies. Yet somehow, in the case of Yahoo!, bears have failed to acknowledge the fundamental impact of the Alibaba investment.
Essentially, Yahoo! trades at just one times sales and four times earnings if you minus the investment in Alibaba. In comparison, Google (NASDAQ:GOOGL), a company with 10% plus top-line growth, trades at five times sales and 26 times earnings if you minus its cash position.
While this comparison does not take into account Google's investments, it's important to note that investing activities have been one of Google's primary cash-burners during the last three years. In each of the last three years, Google has lost more than $10 billion in cash flow from investing activities. Therefore, Yahoo! minus the Alibaba investment compared to Google might not be a direct comparison but does give you an idea of the value in shares of Yahoo!.
One criticism of Yahoo! CEO Marissa Mayer has been acquisitions, such as Tumblr. Yet with a $35 billion asset that is likely to be monetized, Mayer can buy as many Tumblr's as she wishes. In fact, the expected proceeds from Alibaba gives Yahoo! one of the strongest balance sheets in technology per market capitalization, if not the strongest.
Yahoo! has more leverage than either Apple or Google, and unlike its peers, Yahoo! can acquire substantial growth in the years ahead due to its size. Yahoo! has sales of less than $5 billion versus $170 billion and $57 billion, respectively, for Apple and Google. Hence, it'll be easier for Yahoo! to produce growth in the coming years.
Therefore, while Yahoo! is not currently growing, its Alibaba investment alone brightens the company's outlook and should be reason for bulls to be very bullish in the years ahead.
Brian Nichols owns shares of Apple. The Motley Fool recommends Apple, Google, and Yahoo!. The Motley Fool owns shares of Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.