The highly anticipated IPO of Alibaba is right around the corner, and its early investor, Yahoo! is set to gain from the event. Yahoo! will not only be cash rich by selling stock in the IPO, but the company will also be holding onto a chunk of its Alibaba stake, which will aid Yahoo!'s bottom line. This is good news for shareholders as this will help drive the stock.
Impact on earnings
Yahoo! will be selling 10% of Alibaba in the public offering, which is set to take place in the latter part of the year. And Yahoo! will be keeping a 14% stake in Alibaba, which will help its earnings growth. In the last few years, earnings from its two major holdings, Alibaba and Yahoo! Japan, have been a major contributor to the company's earnings per share. In 2013, Yahoo!'s earnings from these two major equity holdings increased 33% to $897 million, which represents 65% of its 2013 net income.
So when Yahoo! sells a sizable portion of its stake in Alibaba, its diluted EPS will get a big boost in 2014. And as Alibaba becomes more valuable, Yahoo!'s fortunes will also increase.
Alibaba saw its revenue grow more than 50% in the last quarter and has a net income margin of around 45%. In addition, Alibaba is making investments in emerging technologies as it made a $215 investment in a rapidly growing mobile messaging service, Tango, which boasts of more than 200 million registered users.
Deployment of excess cash
Yahoo! already has a $5 billion share buyback authorization in place. And the company will likely use that cash to invest in its organic growth projects as well as make acquisitions. If Yahoo!'s cash inflow, from the partial Alibaba sale, is greater than expected the company might opt to increase its buyback program further.
In 2013, Yahoo saw its user base grow substantially to 800 million monthly users, and the mobile user base has surged to 400 million. But the revenue of Yahoo! hasn't followed the growth in its user base. Display advertising revenue declined 9% in 2013, and search advertising revenue declined 8%.
In addition, Yahoo's search partnership with Microsoft (NASDAQ:MSFT) will see contractual changes, which might impact its search revenue. Microsoft gave a revenue per share, or RPS, guarantee in the U.S. for which it made fixed payments to Yahoo! to power its search engine utilizing Bing. But Yahoo! agreed to waive any future RPS guarantee payments from all markets except Taiwan and Hong Kong after first quarter of 2014. So this amended agreement might be a headwind for Yahoo!'s search revenue growth.
So a more optimal usage of cash received from Alibaba would be to invest more in core business to monetize its increased traffic base, and generate more interest from advertisers across various Yahoo! properties, both on the PC and mobile.
The listing of Alibaba in the public equity markets is a big positive for Yahoo! shareholders. The company will be able to monetize a large chunk of its holdings during the IPO and at the same time take part in future growth of Alibaba's revenue and earnings growth. Yahoo! profits should get a major boost in 2014 and 2015, as the company receives proceeds from the sale, invests in its core businesses, and buys back shares.
Ishfaque Faruk owns shares of Facebook. The Motley Fool recommends Facebook and Yahoo!. The Motley Fool owns shares of Facebook. 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.