Yahoo! Inc. Has a Lot of Options After Alibaba's IPO

Investors have debated whether Yahoo is a good buy after Alibaba's IPO, yet given the cash it's about to earn, all indications point towards one answer being overwhelmingly correct.

Mar 31, 2014 at 12:30PM

With a 25% stake in Alibaba, Yahoo! (NASDAQ:YHOO) is about to become a very rich company. Yet, despite the likelihood of Yahoo! trading with a price-to-cash ratio below one, many have observed the fundamental losses that Yahoo! will report following Alibaba's IPO. Despite this fact, the acquisition landscape available to Yahoo is staggering, including the possibility to add a peer like AOL (NYSE:AOL), or maybe even Netflix (NASDAQ:NFLX).

What will Alibaba give Yahoo!?
Alibaba's latest IPO value is estimated around $150 billion, and assuming that it doesn't see a large IPO stock rally, this means that Yahoo! stands to earn more than $35 billion with its 24% stake. To put this in perspective, Yahoo! trades with a market cap of $36 billion, giving it a cash position relative to market capitalization that we have not seen in technology.

Nonetheless, Yahoo! bears claim that more than half of the company's $1.37 billion in net income last year came from its equity interest in Alibaba and Yahoo! Japan. Hence, with an operating income of $590 million last year, some say Yahoo! is more than fully valued at 61 times operating income, implying little upside from the IPO of Alibaba. But does this take into consideration the flexibility that $35 billion in cash will give Yahoo!?

A lot of options
With $35 billion, Yahoo! can do just about anything and it doesn't include the $3.4 billion in cash already on the company's balance sheet. Most figure Yahoo! will seek high-profile acquisitions, companies like Tumblr, or others that can boost its advertising revenue. However, given the enormous opportunity that exists in streaming and video content, investors should expect this to be near the top on Yahoo!'s priority list.

For proof, Re/code reported on Friday that Yahoo! is planning to use higher advertising splits and rates to attract some of YouTube's top networks in an attempt to grow its video presence. Currently, Yahoo! is significantly lagging Google's (NASDAQ:GOOGL) YouTube in video viewership, with just 45 million unique viewers in January compared to YouTube's 158 million. And with YouTube generating more than $5.5 billion last year, it makes sense that Yahoo! would want to grow rapidly and become a leader in this industry.

An almost expected acquisition
With that said, Google is not going to sell YouTube, as it now accounts for more than 9% of the company's total revenue, is growing fast, and has high margins. However, Yahoo! wants a piece of that pie. Therefore, it may seek to acquire a company like AOL, which has a market cap of $3.4 billion, revenue of $2.32 billion last year, and operates a similar business to Yahoo!.

However, one key difference between AOL and Yahoo! from an operational standpoint, is that AOL has become a major player in the video space. Below is a chart, which tells exactly why Yahoo! may be interested in acquiring AOL:

Company

Total Unique Viewers (millions)

Videos (millions)

Minutes per viewer

AOL

76.17

1,414.13

60.4

Yahoo!

53.5

392.5

47.8

Source: comscore.com.

This chart shows data from the month of December, which shows AOL as light-years ahead of Yahoo! in the video. Given AOL's video engagement and volume, it could be a great acquisition to improve in an area of focus for Yahoo!. Moreover, with a market cap of only $3.4 billion, Yahoo! could buy the company with a lot left over.

Let's really speculate
Next, let's really speculate and assume that Reed Hastings will sell Netflix and Yahoo! is willing to buy. This would give Yahoo! a completely new business and an edge over its peers with content rights, a large subscription base, and could have great synergies with its existing video business.

Not to mention, Netflix is a growth company, one that's expected to grow by 23% this year and another 19% in 2015. Also, it ended last year with 31.7 million U.S. streaming subscribers, and is expanding globally, implying that growth in subs should continue. Therefore, with a market cap of $21.5 billion, Netflix would be expensive, but not impossible for Yahoo! to acquire.

Final thoughts
Given Yahoo!'s $38 billion cash position following Alibaba's IPO, plus its current cash on hand, the company could theoretically acquire both AOL and Netflix, whose combined market cap is just shy of $25 billion. Yahoo! could then pay a 50% premium to each company, or raise debt if needed.

So after adding another $6.6 billion in revenue and $400 million in operating income, Yahoo! no longer looks so pricey after the divestment of Alibaba. This is an important point that so many Yahoo! bears forget to acknowledge.

Whether Yahoo! acquires AOL, Netflix, or something else, the company will have options. And with over $38 billion in cash, those options are more than likely to produce large stock gains.

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Brian Nichols owns shares of Yahoo! and Yahoo!. The Motley Fool recommends Google, Netflix, and Yahoo!. The Motley Fool owns shares of Google and Netflix. 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.

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