Yahoo! is facing an unusual and enviable dilemma: what to do with a potential $19.2 billion windfall profit from the Alibaba Group’s impending initial public offering (IPO) scheduled for later this year. Yahoo! owns a 24 percent stake in Alibaba. Industry analysts are estimating projected revenues for the Alibaba IPO may range from $100 billion to a record-breaking $200 billion, according to the New York Times.
At the shallow end of the pool, Yahoo!’s slice of the pie would be $9.6 billion. The gravy at the deep end of the pool: around $19.2 billion. Either way, Yahoo! will still be left with a 14.4 percent equity position in the Chinese company after the IPO is completed, worth somewhere between $14.4 billion and $28.8 billion. (Under its partnership agreement with Alibaba, Yahoo! is required to divest itself of 40 percent of its 24 percent stake upon the IPO.)
Four options appear to be available to Yahoo!’s management: distribute the proceeds from the windfall profit to shareholders, continue Yahoo! CEO Marissa Mayer’s policy of diversification by investing in other up and coming companies, put the money into internal development projects, or some combination of the first three options. The safe bet is on the fourth option.
The Alibaba Group is the Chinese equivalent of Amazon, Dropbox, eBay, Paypal and Google, all rolled together in one company. The closest analogy for the Alibaba’s unique business model is that it does for business to business relationships what the previously mentioned companies have done for person to person, and person to business, relationships in the United States and other countries. Think of Alibaba as a dating site for companies wanting to buy or sell things to each other, and for individuals who want to buy from or sell to companies and you will get a sense of the role the Alibaba group is playing in world commerce.
The privately held Hangzhou-based company reported a 2013 profit of $3.558 billion on revenues of $7.852 billion, for a profit margin of 44.74 percent. For comparison, Amazon booked revenues of $74.45 billion in 2013 but netted only $274 million in real profits for a profit margin of only three-tenths of one percent. Google brought in $57.825 million in revenues in 2013 against net profits of $12.92 billion for an annual profit margin of 22.34 percent. Alibaba has the edge.
Alibaba will be going public in the United States, rather than in Hong Kong, because, under the Hong Kong rules, different classes of voting and non-voting stock are not permitted. The ability to issue different classes of stock is what enables entrepreneurs like Gates, Jobs, Page, and Brin to capitalize their companies, reward loyal employees for their work, and take money out for themselves, without giving up control of the company.
Based on these numbers, Alibaba is a great buy but, right now, the only way to get your hands on Alibaba is to buy one of its publicly traded partners, like Yahoo!, which raises a question of whether Yahoo! will distribute the windfall profit, reinvest them in the company or invest them elsewhere. On the rare occasions where windfall profits have befallen publicly traded companies, management’s failure to distribute at least some of the windfall has resulted in class action lawsuits from disgruntled shareholders. In other cases, companies with windfall profits conserved in their coffers have become targets of corporate raiders, who buy up stock in the company and then attempt to force the company to distribute conserved profits.
Yahoo! may be facing an enviable dilemma with the $19.2 billion windfall from the Alibaba IPO, but it is a dilemma that has pitfalls and pratfalls that could trip up the unwary. Yahoo! would like to avoid such an eventuality.
Founded in 1994, Yahoo! rode the dot.com bubble all the way up to all-time high of $118.75 per share on January 3, 2000, and all the way back down to $4.45 per share on September 21, 2oo1 after the bubble burst. In recent years, the company has been struggling to reverse a decade-long slump during which its stock price dropped from $42.32 US in December of 2005 to a nadir of $9.39 in November of 2008. On January 10 of this year, the company’s stock closed at $41.23, putting in a nine-year high before short-sighted profit takers knocked it back down to $32.62 on April 4th of this year, driven by speculation that Alibaba was not going forward with its own IPO. In recent days, the company’s stock price has been climbing again on the strength of the announcement that Alibaba has decided to move forward with its U.S. IPO.
Right now, there is some question whether the increased interest in Yahoo! stems from speculators looking for a quick profit, or long-term investors hoping to go along for the ride. Whether or not Yahoo!’s increasing share price is a result of investor interest in the Alibaba IPO, Yahoo! is grateful for the boost. The company reported Q1 gross revenues of $1.133 billion against $1.140 billion for the first quarter of 2013.Not a stellar performance, and one largely dependent upon passive income from the company’s investments in Alibaba, Yahoo! Japan, and Tumblr, but the close to flat performance suggests Yahoo! may be finding its stride again despite considerable amounts of adverse comment. Others analysts think the flat performance in the face of adverse reports from some sources is a sign of the company’s true strength.
Note, though, that the lowest windfall profit from the Alibaba IPO at $9.2 billion is twice the company’s full year revenues for 2013 of $4.7 billion. If the IPO hits its number, the windfall will be four times the company’s 2013 gross revenues. Any executive who can quadruple her company’s earnings year over year should get a lifetime contract.
Once the top billing website on the internet in terms of advertising revenues, Yahoo! has fallen from first to third place since 2010, behind Google and Facebook. If the recovery continues, much of the credit will go to Mayer, the 38 year-old recruit from Google, who has been building new products and services into Yahoo! core product since coming over to Yahoo!’s Sunnyvale headquarters, an 11 minute drive Google’s Mountain View campus.
The most important sign a turnaround is in the works is the number of users who frequent the website on a monthly basis. This year, the communications giant is clocking some 800 million visitors per month, up 20 percent since July of 2012, when Mayer took up the reins at Yahoo!. That is far less than 1.23 billion Facebook users and one billion YouTube users, but substantially more than the 680 million monthly Google Plus users.
Mayer, now in the second year of her tenure at Yahoo!, started out by making a series of acquisitions to improve the quality of the user experience, beginning with a campaign to attract more visitors to the site, and especially to lure back former Yahoo! aficionados. Among her recent moves, she has shut down access to Yahoo! through links from Google and Facebook, initiated a streaming video service similar to YouTube, and has green-lighted the development of original programming to attract new visitors, as Netflix has done.
Last year’s purchase of the blog-sharing Tumblr website for a reported $1.1 billion is a case in point. The purchase may not do much for Yahoo!’s bottom line, given Tumblr’s projected revenues of $53 million for FY 2014, but it fits right into Mayer’s agenda for beefing up products and services. Tumblr gives Mayer an inroad into the blogging business, something it now lacks. Blogging sites are increasingly viewed as a source of free or very low-cost content, and blogging site members are famously loyal to their websites.
Mayer’s next task is to figure out how to monetize those users who are being drawn back to Yahoo! by the email service and the new features being added to the website. She is working on developing new advertising products that will be equally attractive to both advertisers and consumers. Already in the works are improved video advertising inserts – essentially identical to television advertisements – and other advertising products that are unobtrusive enough to be tolerated by users but unavoidable enough to be attractive to advertisers.
Calling a company Alibaba recalls one to the famous, if apocryphal, story from the One Thousand and One Arabian Nights (it was added to the text in the 18th century) about a poor wood-cutter named Ali Baba, who discovered a magical thieves’ den accessible only by saying the magic words “Open Sesame.” Those magic words – the password – enabled the poor wood-cutter to pilfer the ill-gotten gains hoarded by the thieves, redistributing the wealth as he saw fit. Ironically, today, many people think Ali Baba was just another one of the thieves (as the thieves themselves might have thought) when he was, in fact, the honest man who bearded the thieves in their own den. If there is such a secret password in the real world, Alibaba founder Jack Ma appears to have found it and now seems ready to share.
Yahoo! faces an enviable dilemma figuring out what to do with its $19.2 billion windfall, which puts the company in the position of being able to pick and choose its own destiny. With that much money, and a sharp eye for a bargain, Yahoo! can transform itself into a high-tech holding company, or stay the course and use the money to challenge the competition – Google, Facebook and YouTube – for their fair share of the traffic on the internet…if their shareholders will let them.
By Alan M. Milner
Look for me on Twitter:@alanmilner