Beware fake arbitrages on Yahoo – Alibaba!
For an arbitrage opportunity to exist, asset classes need to be fungible (deliverable against each other), so anyone selling you a scheme to “arbitrage” an apparent pricing disparity between related, but non-fungible, assets maybe selling you a dud.
When I see investor research by banks, who should know better, promoting “the Yahoo arbitrage trade” whereby the muppets are advised to short Yahoo Japan and Alibaba against a long Yahoo Inc (ie generating 3 trades and 3 commissions), alarm bells ring.Â The logic may seem sound enough in that Yahoo Inc’s shareholding in Yahoo Japan (35%) and Alibaba (16.3%) offer an indirect economic interest in these entities as well as a possible valuation implication on the rump Yahoo inc businesses if these assets are backed out. The problem however is this is a spurious argument ifÂ Yahoo inc shareholders are unable to get direct access to the underlying assets or cash flows and is therefore sensitive to the assumed tax on disposal as well as conglomorate discount which the market would almost certainly also apply.
OK, so let’s look at some numbers on this supposed arbitrage opportunity. At first sight, the Yahoo market cap of approx $40bn drops to nearer $36bn EV after backing out the approx $4bn of net cash (MV and cash assuming the 50% Alibaba IPO proceeds are returned to shareholders via a share buy-back). Against a current MV of its remaining interests in Alibaba (16.3%) and Yahoo Japan (35%) of almost $44bn this might suggest a negative EV is being priced in to the rump Yahoo operations. However, Yahoo’s book values on these are marginal which implies a possible gains tax liability on disposal of over 30%, which would bring the net investment valuation down to nearer $31bn and therefore bring the implied EV of the Yahoo rump up to just over $5bn.Â Against a prospective 2016 EBITA of $675m (consensus) and Op FCF of approx $473m, this would not be unreasonable; reflecting a prospective Op FCF yield of 9.0% and an implied growth rating of approx +3.0% CAGR.
But hang on, isn’t Yahoo inc talking about splashing the Alibaba cash on other acquisitions? What this does is remind us that Yahoo management still stands between investors and the underlying Yahoo assets. Jerry Yang may have played a blinder with Yahoo Japan and Alibaba, but are investors as confident with new girl Marisa Mayer’s ability to spot a bargain on investors behalf?Â If AOL is the great new play, perhaps not, which just re-enforces the perception that a conglomorate discount will also be applied by markets as we’ve seen with the likes of Vivendi, Lagardere and countless other groups in the recent past.
If the implied valuation of the Yahoo rump is only just about OK when the post tax valuations of its investments are backed out, then applying a conglomorate discount of anywhere between 10-20% on these is going to make the whole ‘arbitrage’ deal a rather pointless and possibly expensive exercise, at least for the investor rather than the promoter, who stands to gain possibly 3 commissions and possibly also a spread or two!
Yahoo valuation (sum of parts)