Internet giant Yahoo! is at a crossroads of epic proportions. There's perhaps no other company with a larger divergence between the values of its various assets. Put simply, Yahoo!'s core businesses are in decline, and yet, the stock surged in 2013.
For investors wondering how this could possibly be true, the answer can be found within its stakes in various Asian assets. Those assets are extremely valuable, and are the biggest consideration you should keep in mind before buying shares of Yahoo!.
A clear divergence in Yahoo!'s valuation
Yahoo!'s core search and display businesses aren't doing well, and that shouldn't be a surprise. For many years, those sites have lost a great deal of market share to Google (NASDAQ:GOOGL). Consider that through the first nine months of 2013, Yahoo!'s display and search segments posted revenue declines of 10% and 9%, respectively. By contrast, Google's revenue, excluding its Motorola Mobile business, rose 20% through the first nine months of its own fiscal year.
And yet, shares of Yahoo! soared last year, defying any sense of pessimism surrounding its core businesses. Yahoo! saw its share price more than double in 2013. In fact, at a recent price of $40 per share, Yahoo trades for 35 times trailing earnings.
Meanwhile, Google exchanges hands for just 31 times trailing EPS. That means that Yahoo is actually more aggressively valued than Google, despite the fact that Google is reporting much better underlying performance than Yahoo. How could this be true?
The answer is that investors need to look overseas to unlock Yahoo!'s value. Yahoo! holds a 24% stake in Chinese e-commerce giant Alibaba. Alibaba, which operates a similar business as Amazon.com and eBay, is immensely valuable. Alibaba processed about $160 billion in products in 2012, more than eBay and Amazon put together.
Analyst estimates place Alibaba's value, once it eventually goes public, at between $130 billion and $190 billion. As a result, at the midpoint of that range, Yahoo!'s stake would be worth approximately $38 billion. That in itself accounts for about $37 per share, using Yahoo's share outstanding count at the end of its most recent quarter.
In addition, Yahoo!'s Japan business is performing well. Yahoo! is arguably the king of search in Japan, besting even Google. Yahoo! Japan posted 20% revenue growth in its fiscal third quarter, as well as 20% growth in its quarterly net income. As a result, Yahoo! Japan makes up the rest of Yahoo!'s valuation.
Yahoo!'s increasing valuation multiple is due squarely to rising optimism over its incredibly valuable Asian assets. Those are what really matter to Yahoo! -- not its American businesses.
Alibaba is the key to Yahoo!'s future
It's natural to question Yahoo!'s meteoric rise in share price in 2013, especially considering its tepid underlying business performance. At first glance, it seems highly irrational for Yahoo! to hold a higher valuation than Google.
The truth is that Alibaba, as well as Yahoo! Japan, hold immense potential for Yahoo! as a whole. Those are the reasons why Yahoo! shares surged in price last year, despite its traditional U.S.-based businesses floundering. The simple truth is that Yahoo!'s American segments are in significant decline. Despite the media hype surrounding Marissa Mayer's restructuring efforts, little progress (if any) has been made in turning around Yahoo!'s American business entities.
Alibaba is set to undergo an initial public offering at some point in 2014, meaning Yahoo! will soon reap the rewards of a massive financial windfall. That's what explains Yahoo!'s soaring valuation over the past year. For those interested in buying shares of Yahoo!, it's important to know what you're buying.
More compelling ideas from The Motley Fool
Opportunities to get wealthy from a single investment don't come around often, but they do exist, and our chief technology officer believes he's found one. In this free report, Jeremy Phillips shares the single company that he believes could transform not only your portfolio, but your entire life. To learn the identity of this stock for free and see why Jeremy is putting more than $100,000 of his own money into it, all you have to do is click here now.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, eBay, Google, and Yahoo!. The Motley Fool owns shares of Amazon.com, eBay, 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.