The Marley Group

Hold
12 Month Target $35.00

The Marley Group initiated coverage on Yahoo! (YHOO) nearly 6 months ago with a ‘Strong Buy’ rating and set a price target of $32.00. Shares of the company have since appreciated to our estimate, making this an appropriate time to offer an updated outlook on the company.

With vastly improved levels of investor sentiment driving a 36% appreciation in shares of Yahoo! since recommending purchasing them in October, the stock is trading at a valuation much closer to fair value. Contributing largely to the aforementioned improvement in investor sentiment surrounding Yahoo!, are reports that the roll out of the long awaited upgrade to their search marketing platform, Panama, has been going smoothly and has been receiving positive feedback from customers.

Given the positive response to Panama, we are sticking by our view of Yahoo! earning $0.72 per share for the year. With initial reactions being positive thus far, a good deal of investor concern has been lifted, reflected in Yahoo!’s strong advance these past few months. Taking this improved sentiment and lessened risk associated with the company after initial reports of a successful Panama launch into consideration, shares are positioned to further return to normalized valuation levels, causing us to raise our target price to $35.00 per share. While a realization of this estimate would represent a 9% gain from current levels, Yahoo! is no longer irrationally undervalued relative to their peers. Therefore, we are updating our view accordingly, reducing our rating on Yahoo! to a hold on valuation grounds.

Disclosure: Joseph Urgo does not have a position in Yahoo!.

Dear Mr. Semel,

I am not writing to question your leadership and management of the Yahoo! (YHOO) web properties, as there are already enough sources applying pressure there, but rather I am going to question the management of Yahoo!’s assets and balance sheet. Also, I will outline a few possible ways to address the problems that I highlight and share my views as to why these measures are in the best interest of shareholders.

Yahoo! has a sizable portfolio of equity investments as well as cash and cash equivalents. The asset of greatest interest is your 33.43% equity stake in Yahoo! Japan, worth about $8.3 billion based on yesterday’s closing price. Based on our research and analysis, we believe your company’s shares are currently undervalued by at least 20%. We view the lack of financial visibility created by your stake in Yahoo! Japan as a cause of your stock’s underperformance. There are two ways that this problem can be quickly corrected.

The first solution would be to unload your stake in Yahoo! Japan. There is no better way to improve your company’s financial visibility. It would add over $8 billion in cash to your balance sheet, bringing Yahoo!’s total cash on hand to over $10 billion. There are countless ways that such an amount of cash could be utilized. Most effective though, based on our view of your business being at least 20% undervalued, would be to greatly reduce the amount of outstanding shares of Yahoo! through a massive tender offer. Considering a modest 10% premium over the most recent closing price, about $29.00 per share, 25% of outstanding shares can be retired through such an offer. This will result in greatly improved financial ratios, which the market puts a great amount of emphasis on. Also, the reduction of assets and outstanding equity will result in significantly higher returns on both assets and equity.

Should you be adamant in maintaining a large position in Yahoo! Japan, we would like to see the stake upped to a level ranging between 51% and 54% of shares outstanding, preferably 54% to ensure that a majority stake is maintained even after share dilution stemming from future stock option grants. The cost of acquiring an additional 20.57% stake in Yahoo! Japan, the amount needed to give your company 54% ownership, would be $5.1 billion based on Yahoo! Japan’s most recently quoted market price. For the purposes of this letter though, we will assume a cost of $5.5 billion, as a premium to the current market value will most likely have to be paid to acquire such a sizable position. As a direct result of becoming the owner of a majority stake in Yahoo! Japan, your company would instantly gain greater financial transparency and benefit from your assets rather than hide shareholder value within them. As majority owners, you would be able to include the results of Yahoo! Japan’s operations with your own, a move that would be extremely accretitive to both the top and bottom line. In the past four quarters of operation, Yahoo! Japan has reported revenue of $1.68 billion, operating income of $812 million, and net income of $454 million. Including these figures with your own would boost your revenue by 17%, your operating income by 84%, and your net income by 62%. The impact this would have on your companies market value would be substantial. Based on all of the major valuation ratios, your companies shares should appreciate in value. As stated before though, such a deal would cost nearly $5.5 billion, which is much more than your available cash on hand. Given your $36 billion market cap, taking on a debt to equity ratio of just 0.1 would be enough to finance the remainder of the purchase.

While viewing the first proposed measure as the more favorable of the two, either of the two will result in greater visibility and greatly improved financial ratios, which will drive an appreciation in the value of Yahoo!’s shares. As CEO, it is your duty to generate returns for shareholders. Given this fact, both proposals should be immediately reviewed as they are in the interest of shareholders.

Sincerely,
Joseph Urgo

Late Friday, a senior Vice President at Yahoo! (YHOO) issued a four page memo calling for significant changes at the company. Dubbed “The Peanut Butter Manifesto,” the memo points out how Yahoo! has essentially spread itself too thin by engaging in too many concurrent business ventures to effectively compete. It calls for a refocusing of Yahoo!’s efforts, a reorganization of the companies currently “bureaucratic” structure (which includes a suggested 15% to 20% reduction in headcount), and more accountability for top executives.

We view the release memo as a significant point in Yahoo!’s existence and believe the street will agree. This should be seen as a wake up call for the entire company, Yahoo!’s strong assets need to be leveraged properly and efficiently if they are to generate the financial returns that they should. A restructuring such as the one proposed in “The Peanut Butter Manifesto” would actually increase productivity while cutting costs, by enhancing interoperability within key business areas and the corporation as a whole while reducing salary expenses.

Cost cutting measures alone will lead to improved financial results. If the proposed measures occur, there exists an upside potential of at least $0.04 to our previous FY 2007 estimate of $0.72, based on headcount reductions alone. Also, a more focussed approach should yield a much improved reinvestment rate, allocating more of their resources to a few core business initiatives rather than a myriad of ventures. Combined, Yahoo! would be greatly positioned to post some impressive results in 2007. We reiterate our Strong Buy rating on shares of Yahoo!.

Disclosure: Joseph Urgo does not have a position in Yahoo!.

Strong Buy
12 Month Target $32.00

The Marley Group has issued a strong buy rating on shares of Yahoo! (YHOO), following up the earlier released research note Has Yahoo! Bottomed Out?. Coverage on Yahoo! is being initiated with a buy rating and a 12 month price target of $32. Discounting the $10 in cash and equity investments that Yahoo! has on their balance sheet, we see fair value for Yahoo!’s business at $22 per share based on our FY 07 earnings estimates of $0.72 and a reasonable P/E ratio of 30, considering an earnings growth rate estimate of 30% for the year. We believe that Yahoo! has the potential to earn $0.72 in FY 07, an upside of $0.12 to current consensus estimates, with the roll out of their long awaited search marketing platform upgrade and continued enrichment of their user experience through new offerings and the continued integration of smaller acquisitions. Yahoo! is well positioned to capitalize on the expected surge in online video advertisement growth and continued shift of marketing budgets towards the web and away from old media. Considering our downside estimate of $22 per share on Yahoo!, the risk here looks small when considering the upside potential for shares after losing more than 40% of their value this year. We view Yahoo! as a very attractive investment at current levels.

Disclosure: Joseph Urgo does not have a position in Yahoo!.

Following their dismal Q3 Report, investors sent shares of Yahoo! (YHOO) to their lowest levels since March 2004. Despite the fact that they still sport a P/E ratio of 48, they are starting to look like a value stock in some respects.

While at first glance Yahoo!’s P/E ratio looks very high at 48, it is necessary to take Yahoo!’s cash and strong investment portfolio into consideration. This investment portfolio includes a 34% equity stake in Yahoo! Japan, worth between $6 and $7 per Yahoo! share, as well a stake in Chinese internet company Alibaba worth about a $1 per share. Add almost another $2 per share of cash on hand and you get nearly $10 per share in cash or equity stakes. To get a better picture of what the street is currently valuing Yahoo!’s business at, we can knock $10 off the current share price of $23 and determine that Yahoo!’s business is currently being valued at $13 per share outstanding. This adjustment will greatly effect all of Yahoo!’s valuation ratios. Their forward P/E ratio falls from 39 to 20, compared to 32 for Google. Their expected Price to Earnings Growth ratio falls from 2 to 0.8, much lower than Google’s PEG ratio of 1.1.

While shares of Google should trade at a premium to Yahoo!, the difference between their forward P/E ratios, 32 and 20 respectively, is too great. Following another disappointing quarterly report, shares have been driven low enough that Yahoo! now looks like a value play relative to their peers in the volatile internet sector. This should guard against further downside in the stock. Shares should have downside of $22, guarded by the ratios discussed earlier and a new $3 billion buyback announced just last week. Both analysts and management have lowered their predictions to levels where future surprises to the upside are much more likely. Not withstanding a downturn in the market before the end of Q4, the only way shares of Yahoo! should see lower than $22 is if management feels the heat to acquire and overpays for a major web property, most likely Facebook, after Google’s highly publicized acquisition of YouTube for $1.65 billion.

Yahoo! announced that they have started rolling out their long anticipated upgrade to their search marketing platform, which is expected to help Yahoo! better compete with Google for advertisement revenue. Yahoo! continues to enrich their user experience with widespread beta roll outs of their new mail service, a much improved homepage, and improvements to their popular Finance site. They have also been quietly strengthening their video offerings after purchasing video sharing site JumpCut and video advertisement firm AdInterax. The combination of these events may be what the company needs to get some momentum behind them once again, and could very reasonably lead to an upside surprise on both the top and bottom lines. After falling more than 40% this year, it appears that a bottom may finally be in place for Yahoo!.

Disclosure: Joseph Urgo does not have a position in Yahoo!.