Why Yahoo Is Screwed after the Alibaba Deal
It's funny how money can somehow seem to start vanishing even before you can finish counting it all. Just ask Yahoo CEO Marissa Mayer.
No sooner did the company announce the sale of about half the shares it owns in Alibaba than it became clear that only a tiny fraction of that amount will be left over for the company to finance its future growth.
The sale of Alibaba shares, which Yahoo shareholders had long been clamoring for, took months to complete. But for all the headaches the Alibaba investment has caused Yahoo, the decision to buy a 40% stake of the young e-commerce company in 2005 was a highly profitable one.
In addition to the $6.3 billion Yahoo is getting in cash, it will still own a piece of Alibaba valued at $8.9 billion – including its remaining 23% stake as well as the new preferred shares that Alibaba gave Yahoo in exchange for its common shares. That marks a 15-fold return on a seven-year investment.
No question about it: Making $7.6 billion for selling only half of a billion-dollar investment is a nice bit of dealmaking, even if $550 million of the sum is coming from an IP licensing agreement. Just think what Yahoo could buy with several billion dollars. It could compete for high-priced engineering talent in Silicon Valley. It could make a big bold bet or two - like Foursquare or Tumblr - or a lot of small, strategic ones that, as Sarah Lacy argued recently, was Yahoo's best course for remaking itself as a web giant. (Not to mention the plan one that Silicon Valley VCs were selfishly hoping to see.)
Such were the hopes of Yahoo believers in recent weeks. And there was good reason for that hope. In August, only a few weeks after Mayer joined Yahoo as CEO amid a wave of great expectations, Yahoo said in a filing that “Ms. Mayer is engaging in a review of the Company’s business strategy to enhance long term shareholder value.” Those final five words are Wall Street parlance for “You might have to wait a few years to collect your returns.”
In case this was too euphemistic for some investors, the filing went on to note that Mayer's “review process may lead to a reevaluation of, or changes to, our current plans, including our restructuring plan, our share repurchase program, and our previously announced plans for returning to shareholders substantially all of the after tax cash proceeds of the initial share repurchase by Alibaba Group.”
Investors didn't take that news so well. Yahoo's stock fell 10% over the next week.
But that warning was widely seen as good news for Yahoo's own prospects. It meant adding billions of dollars in cash to the $1.9 billion it had on hand in June. It meant having the money needed for a quick rebuilding project, and having a broader range of options to remake the company.
But now it seems Yahoo will have much less cash for any expansion plans. It was clear that Yahoo wouldn't get the full $7.6 billion. There are were fees for handling the deal, not to mention taxes. And Alibaba was paying $800 of the sum in a different class of equity, not cash. So with all that factored in, Yahoo was left with $4.3 billion in cash. But still, quite the bulging billfold.
But only a small minority of the proceeds would go toward its own coffers. Where did the rest go? In the press release announcing the transaction, Yahoo said that 85% of the cash proceeds – or $3.65 billion – would go to shareholders. In fact, Yahoo had already spent $646 million of the money on share repurchases – essentially paying out existing shareholders who wanted to sell their Yahoo holdings.
That remaining 15% - equal to $650 million – is Mayer's to spend. In a memo to employees, Mayer described that figure as “a meaningful amount,” but it's not going to buy a lot of Foursquares. It could, however, buy a lot of smartphones.
The shareholder-friendly disbursement makes you wonder why Yahoo would risk a 10% selloff by warning investors that it would use the Alibaba proceeds to finance long-term growth rather than a short-term strategy of stock buybacks – a warning that proved pointless. How many shares did Yahoo repurchase during that selloff?
There are strategic reasons for Yahoo to bay the bulk of the Alibaba proceeds to its investors. It will quiet demands for a payout – at least until they start itching for the remaining $9 billion Yahoo owns in Alibaba. And if it stabilizes or even lifts the stock price, that could encourage Yahoo employees who own company shares or options as well as make option packages more attractive to potential hires.
But there's no guarantee that $3 billion will shore up a company valued at $19 billion for a very long time. It could, however, shore it up long enough for investors to cash out. In fact, it could offer an exit sign for investors who were for this payout to reduce their holdings in the company.
That must be good news for Daniel Loeb, the activist shareholder at hedge-fund Third Point, who prompted the departure of Mayer's predecessor, won three seats on Yahoo's board and helped oversee Mayer's hiring. A Reuters story in early August quoted an anonymous source as saying Loeb backed Mayer's plans to re-evaluate its Alibaba proceeds. But only a week or so earlier, Loeb notified investors in his fund that Yahoo would likely return the proceeds to shareholders.
It remains to be seen whether the $650 million Yahoo is adding to its cash pile is in fact a “meaningful amount.” If Mayer focuses her dealmaking on the small, targeted acui-hires that Facebook is excelling at, it could be.
But the $650 million figure is meaningful in other, more symbolic ways. It's less than 9% of the money Yahoo is receiving from Alibaba – and less than the $1 billion Yahoo invested in Alibaba seven years ago.
That means that Mayer has a lot less financial resources at her disposal than she looked to have a month ago. More troublingly, it may mean she's been put on a short leash, that the activist investor is still calling the shots at Yahoo. And that could mean layoffs instead of bold dealmaking is the future of Yahoo. If so, that will make Mayer's already dubious task at remaking Yahoo a lot harder.